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Why Inflation Swap Rates Can Differ From Treasury Breakevens

Article Quant Q&A · Author: tennisboy
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Summary

This note compares zero-coupon inflation swap rates with Treasury breakeven inflation rates. A breakeven rate is calculated as the nominal Treasury yield minus the real yield on a Treasury Inflation-Protected Security of the same maturity. Since TIPS are less liquid than nominal Treasuries, their relative pricing can affect the breakeven rate; the answer identifies this liquidity difference as the main explanation for a gap between the two measures.

Other factors can also contribute, including yield-curve shape and differences between zero-coupon swap rates and par yields. The note offers a qualitative explanation rather than a decomposition or empirical estimate of each effect. Its example rates are tied to the question’s stated market snapshot and should not be read as current or universal values.

Key ideas

  • A Treasury breakeven rate is the nominal Treasury yield less the real TIPS yield at the same maturity.
  • Lower TIPS liquidity can influence relative pricing and depress the breakeven measure.
  • Zero-coupon swap rates and par yields differ in construction.
  • Yield-curve shape can also contribute to differences between the measures.
  • The explanation identifies likely drivers but does not quantify their separate effects.

Tags

Fixed income
Full text
# Inflation swaps rate vs. Break-even rate


# Inflation swaps rate vs. Break-even rate












Can someone explain me the difference between zero coupon inflation swap rate and breakeven rate? For example, currently, US 10y zero coupon inflation swap rate is about 1.4%, while US breakeven 10y rate is about 1.3%. Is liquidity the main driver for the difference?

Thanks

## Answer by dm63 (score 5)

https://quant.stackexchange.com/a/53317

Yes, you could call this a liquidity effect. The 10yr breakeven rate is defined as the difference between the nominal yield of the 10yr Treasury and the real yield of the 10yr TIPS. The TIPS has less liquidity than the Treasury, so trades at a discount (in the sense of asset swap levels).

There are a few other effects to do with the shape of the yield curve, zero coupon rates versus par rates and the suchlike, but the main effect is as described. It has been persistent over time.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.