Inflation-Linked Bonds and Breakevens

Price TIPS-style bonds and read the market's inflation expectations: inflation-adjusted principal and coupons, real and nominal yields, breakeven inflation by tenor and over time, and the value of the deflation floor.

Learning focus: what breakevens measure, and why they are not pure inflation forecasts.

Bond

Settlement

Dated date

Maturity

Real coupon

Face

Start from

Real yield

Inflation index

Reference CPI, dated date

Reference CPI, settlement

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Assumptions

Inflation

Inflation volatility

Nominal Treasury yield

Invoice price (clean)

101.6094

1,022,396.99 with accrued, for 1,000,000

Index ratio

1.01398

326.50000 ÷ 322.00000

Inflation-adjusted principal

1,013,975

101.3975 per 100

Real price

100.2090

Next coupon

9,545.65

2027-01-15, at a projected index ratio of 1.01820

Nominal yield at 2.50% inflation

4.358%

Breakeven inflation

2.342%

nominal − real: 2.350%

Deflation floor

0.0000

per 100; principal index at maturity 1.272

Real duration

8.339

What a breakeven measures

If inflation averages more than 2.34% a year to 2036, this TIPS beats the nominal Treasury; less, and the Treasury wins. A breakeven is not a clean forecast. It is expected inflation plus an inflation risk premium that nominal bondholders demand, minus a liquidity premium on TIPS, which trade less than nominal Treasuries. In a sell-off TIPS liquidity dries up first, so breakevens can fall even when inflation expectations have not, as in late 2008.

Breakeven inflation by tenor

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Breakevens against actual inflation

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Projected cash flows

Date	Index ratio	Adjusted principal	Coupon	Principal	Total
2027-01-15	1.01820	1,018,202	9,545.65		9,545.65
2027-07-15	1.03085	1,030,851	9,664.23		9,664.23
2028-01-15	1.04366	1,043,657	9,784.29		9,784.29
2028-07-15	1.05662	1,056,622	9,905.84		9,905.84
2029-01-15	1.06975	1,069,749	10,028.89		10,028.89
2029-07-15	1.08304	1,083,038	10,153.48		10,153.48
2030-01-15	1.09649	1,096,492	10,279.62		10,279.62
2030-07-15	1.11011	1,110,114	10,407.32		10,407.32
2031-01-15	1.12390	1,123,905	10,536.61		10,536.61
2031-07-15	1.13787	1,137,867	10,667.50		10,667.50
2032-01-15	1.15200	1,152,002	10,800.02		10,800.02
2032-07-15	1.16631	1,166,314	10,934.19		10,934.19
2033-01-15	1.18080	1,180,802	11,070.02		11,070.02
2033-07-15	1.19547	1,195,471	11,207.54		11,207.54
2034-01-15	1.21032	1,210,323	11,346.77		11,346.77
2034-07-15	1.22536	1,225,358	11,487.73		11,487.73
2035-01-15	1.24058	1,240,581	11,630.44		11,630.44
2035-07-15	1.25599	1,255,992	11,774.93		11,774.93
2036-01-15	1.27160	1,271,595	11,921.20	1,271,595	1,283,516.29

Projected at 2.50% inflation a year from today's index ratio. Principal at maturity is the greater of the adjusted and the original face.