Yield Curves and Break-even Inflation
In this post, I will show how to automatically import the most up-to-date yield curve data into a Google Docs Spreadsheet using the “ImportXML” function. This yield curve data is useful for many financial calculations, but in this post I will again use the yield curve data to do a rough estimate of the break-even inflation rate.
Read the “Notes on the Break-even Inflation Calculation” section for an explanation of the break-even rate and a clarification on why the method shown only gives an approximation of the break-even rate.
ImportXML Function in Google Docs
The ImportXML function can be used to import data from XML files. The syntax of the command is:
The ImportXML example shown here will import the real 5-year yields into the spreadsheet.
The “//TC5_YEAR” is an xpath expression which selects all the nodes named “TC_5YEAR” in the target document. Other maturities in the document can be selected by changing the node name. For example, the 30-year real yields are selected by changing the xpath expression to “//TC_30YEAR”.
Example Google Docs Spreadsheet
I have created an example Google Docs spreadsheet which uses the ImportXML data to download the real and nominal yields at several maturities. The example sheet is read-only, but if you would like to customize you can select “make a copy” from the “File” pull-down and edit the copy of the spreadsheet. You must be logged into your Google Docs account to make a copy.
The spreadsheet automatically imports the yield information for the current month to the sheet labeled “Yields”. The “Summary” sheet extracts the most recent set of daily yield curve data from the “Yields” sheet and uses it to estimate the break-even inflation rate. The yield curves and the breakeven inflation curves are plotted in the “Summary” sheet as shown here:
This example chart uses yields from 8/21/2012, but the actual spreadsheet will automatically generate a new chart using the most recent yields available.
Notes on the Break-even Inflation Calculation
There are several reasons why the break-even inflation rate is not a perfect estimate of inflation expectations. Also, the method shown here is not the most accurate way to calculate the break-even rate.
First, regular Treasury bond investors bear a risk of unexpected inflation, and Treasury yields have a risk premium to compensate for this uncertainty. The real yields based on TIPS do not include this risk premium, so it shows up as part of the break-even rate. A second distortion is that TIPS are less liquid than Treasuries, so TIPS yields contain a liquidity premium which Treasuries do not have. Finally, the TIPS yields are adjusted by CPI, and some investors are skeptical of this inflation measure. If you don’t believe CPI, then you might be skeptical of the break-even rate since this is a measure of expected CPI.
Another issue with the method shown is that the yields downloaded are the yields for coupon bonds. These bonds pay a coupon every six months, and this means that the duration of the bond is less than the maturity. So, the yield for the 30-year bond is a weighted average of interest rates at various payment maturities (all the coupon and principal payments) and is not a targeted measure of the 30-year interest rate.
To be more accurate, we should calculate the break-even rate of inflation using zero-coupon bond yields. This requires that the zero-coupon yield curve be bootstrapped from the curve for coupon bonds. Unfortunately, this complicates the analysis considerably. My previous post on this topic used Octave to bootstrap the zero-coupon curve, but in this simple example I’m sticking with the coupon yields. Users of the spreadsheet should be aware of this inaccuracy. Also, note the when interest rates are low, as they are today, the distortion due to this simplification is relatively small, but when rates rise the distortion will be larger.