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There’s an easy way for investors to tell when market participants are growing increasingly concerned about more sustained upside risk to inflation: It’s when 5- or 10-year breakeven inflation rates rise above 2.5%.
Breakeven rates are a measure of what market participants expect average inflation to be over the next 5 or 10 years. As of Wednesday, the most recent day in which data is available from the St. Louis Fed, 5- and 10-year breakeven rates were respectively at 2.1% and 2.21%.
Both rates have remained mostly below 3% for more than 21 years. One of the few exceptions was after Russia’s invasion of Ukraine in February 2022, when the 5-year breakeven rate spiked above 3% for a few months and its 10-year counterpart rose close to that level.
Tim Magnusson, chief investment officer of Minnesota-based Garda Capital Partners, said that “if we were to get back to, say, 2.5% breakeven in the 5-year sector, that would be a flag to me that the market is concerned about a second wave” on inflation. However, “I don’t see us heading there any time soon.”
Meanwhile, Omair Sharif, founder and president of Inflation Insights, said that the 10-year breakeven rate’s historical average is close to 2%, so “a break above 2.5% would be a little bit concerning.” “If we get there, that tells you people are pricing in a more sustained upside risk to inflation.”
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