Quick comment on breakevens

I noticed guys noting that the 10-year breakeven has declined slightly and inferring from this that the “reflation” trade may be over.

In my view, the low-hanging fruit in the breakevens has been picked as investors – I assert – have come to accept that the Fed will be comfortable allowing inflation to overshoot 2% slightly in the late cycle in order to compensate – on a purely forward looking basis – for the likely undershoot come the next recession and early recovery. Can’t prove it, but that would be my interpretation. I still think this has a ways to go, but my confidence is lower in a further move from here.

That aside, I think a lot of the commentary around this issue just confuses movements of oil prices with inflation “expectations.”  The real bonds are indexed to CPI with a lag, which will tend to drive up the measured inflation compenstation in the wake of a big oil price rise (and vice versa), even if inflation expectations looking purely forward are unchanged.  TIIs traders know this and I find it hard to believe that journalists do not, but they still seem to call lower oil prices a fall of inflation “expectations.”

One way to get around this would be to calculate the 3-month forward 10-year breakeven, which would be free of the purely mechanical effects of delayed indexation, although not the more fundamental issue of people seemingly tending to extrapolate (wrongly) minor inflation pulses from oil. Those are two separate issues.

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Lacking that measure, I prefer just to look then at the 5X5 breakeven, which is definitely overkill from the perspective of controlling for that lagged inflation indexing issue but is as a result of that overkill clean in this regard.

My chart is delayed a couple days, cuz FRED is a bit sluggish. But not much has been going on there. And in the past few sessions oil has begun to come back anyway.  There are some additional (liquidity / calculation) issues beyond what I have noted that make my own interpretation also imperfect. So better still would be to cross check with a TIIs trader before taking seriously anything the typical journalist says on this.