How do you calculate the inflation breakeven rate from TIPS and nominal Treasury yields?

The inflation breakeven rate is the market-implied inflation expectation derived from the yield difference between nominal Treasury bonds and Treasury Inflation-Protected Securities (TIPS) of the same maturity.

Formula:

Breakeven Inflation Rate = Nominal Treasury Yield - TIPS Real Yield

Example:

• 10-year nominal Treasury yield: 4.25%
• 10-year TIPS real yield: 1.80%
• Breakeven inflation = 4.25% - 1.80% = 2.45%

Interpretation: The market expects average annual inflation of 2.45% over the next 10 years. This is the rate at which an investor is indifferent between holding nominal Treasuries or TIPS.

Decision Rule:

If You Expect...	Action	Why
Inflation > 2.45%	Buy TIPS	TIPS will outperform because inflation adjustment exceeds the yield sacrifice
Inflation < 2.45%	Buy nominal Treasuries	Higher nominal yield wins when inflation is lower than priced
Inflation = 2.45%	Indifferent	Both strategies deliver the same real return

Worked Comparison — Mercer Portfolio (fictional):

Invest $100,000 for 5 years:

Scenario: Actual inflation averages 3.5% (above breakeven of 2.45%)

• Nominal Treasury (4.25%): Real return ≈ 4.25% - 3.50% = 0.75%/year
• TIPS (1.80% real): Real return = 1.80%/year guaranteed
• TIPS wins by ~1.05% annually in real terms

Scenario: Actual inflation averages 1.5% (below breakeven)

• Nominal Treasury: Real return ≈ 4.25% - 1.50% = 2.75%/year
• TIPS: Real return = 1.80%/year
• Nominal wins by ~0.95% annually

Limitations of Breakeven as Inflation Forecast:

1. Includes an inflation risk premium — investors demand extra yield for uncertainty, so the breakeven overstates expected inflation
2. Includes a liquidity premium — TIPS are less liquid, pushing their yield up (narrowing the breakeven)
3. These two premiums partially offset each other

Exam Tip: Know the breakeven formula, the decision rule, and that the breakeven rate is not a pure inflation expectation — it includes risk and liquidity premiums.

Practice inflation-linked securities in our CFA Level I bank.