Bond Market’s Inflation Expectations Near Fed’s Target

Federal fund futures were pricing in a high probability of an interest rate cut being announced following the September Federal Open Market Committee (FOMC) meeting as we went to press.

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Federal fund futures were pricing in a high probability of an interest rate cut being announced following the September Federal Open Market Committee (FOMC) meeting as we went to press. If an interest rate cut were to be announced, it would be the first one since March 2020.

Given this, we provide an updated look at the breakeven inflation rate. The breakeven rate reflects the bond market’s expectations for future inflation. The St. Louis Federal Reserve makes two breakeven inflation rates available in its FRED online database: the five- and 10-year breakeven rates. For these two time frames, the breakeven inflation rates are the difference between the yields of nominal (fixed-income) Treasury bonds and Treasury inflation-protected securities (TIPS) bonds, each with maturities of five or 10 years, respectively.

As of mid-August 2024, the five-year breakeven rate of 1.97% was below the Federal Reserve’s 2.00% target rate for inflation. The 10-year breakeven rate was close to it at 2.08%. Both coincide with declines in the 12-month consumer price index (CPI). The 12-month change in the CPI was 2.9% in July 2024.

The charts here highlight the current breakeven rates, with arrows showing two prior breakeven points for comparison. We last featured the breakeven rate in the June 2022 AAII Journal (“Breakeven Rates Signaling a Potential Slowing of Inflation”). That article followed one we published in the July 2021 AAII Journal (“The Bond Market’s Expectations for Inflation”).

There is no knowing what the FOMC will ultimately decide at its September meeting. Expectations can change quickly. We saw this occur early in the year when expectations for several interest rate cuts throughout 2024 quickly vanished. Still, the ongoing pullback in the headline inflation numbers and the gradually declining breakeven rate does provide the FOMC room to act if it so chooses.