Investing - Theory, News & General • BEI refresher

Given some recent discussions, I thought it would be good to do a breakeven inflation (BEI) refresher.

I find this article from the Fed to be highly informative:Tips from TIPS: Update and Discussions.

In that paper there is a derivation of an equation for BEI:

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By standard economic theory, nominal and real yields can be decomposed as:

nominal yield = real yield + expected inflation + inflation risk premium; (1)

real yield = expected average future real short rate + real term premium, (2)

where the inflation risk premium and the real term premium are extra compensations bond investors demand for bearing inflation risks and real interest rate risks, respectively. Nominal and real forward rates can be decomposed in the same way.

In the model, TIPS yields typically exceed "true" real yields (or real yields that are consistent with nominal yields) due to the TIPS liquidity premium:3

TIPS yield = real yield + TIPS liquidity premium. (3)

As a result, TIPS inflation compensation (IC)—defined as the nominal yield minus the TIPS yield—can be decomposed into three components,

TIPS IC = expected inflation + inflation risk premium – TIPS liquidity premium. (4)

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Note that "TIPS IC" is their term for BEI, i.e., "the nominal yield minus the TIPS yield." So I'll rewrite the equation using the more familiar BEI:

BEI = expected inflation + inflation risk premium – TIPS liquidity premium. (4)

So the inflation risk premium embedded in the nominal yield increases BEI relative to expected inflation, and the TIPS liquidity premium embedded in the TIPS yield decreases BEI relative to expected inflation.

I visualize BEI as the gap between nominal yield (above) and TIPS yield (below), with the the inflation risk premium pushing the nominal yield up, increasing the BEI gap, and the TIPS liquidity premium pushing the TIPS yield up, decreasing the BEI gap.

The authors go on to explain the two premiums a bit more:

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TIPS IC can deviate from expected inflation for two reasons: a non-zero inflation risk premium or a non-zero TIPS liquidity premium. The first term, inflation risk premium, is the extra compensation nominal bond investors demand for bearing inflation risks, and its value depends on the covariance between inflation and real economic activity. This premium is believed to have been positive and sizeable in the 1970s and 1980s, when investors were more worried about stagflation scenarios with higher inflation accompanied by lower growth, but appears to have declined in recent decades to lower or even negative levels, as investors have become more concerned about outcomes where lower inflation is associated with lower growth.4

By contrast, TIPS liquidity premium is not connected to inflation risk but rather reflects factors that drive a wedge between TIPS yields and true real yields. This premium was high when TIPS was first launched, as it took some time for TIPS to gain popularity among investors, and again surged during the 2008-2009 Financial Crisis, as investors fled from less liquid or more risky instruments and sought the safety and liquidity of nominal Treasury securities. Apart from lower liquidity of TIPS relative to nominal Treasuries, this premium may also reflect supply-demand imbalance of TIPS versus nominal securities and a greater concentration of buy-and-hold investors in TIPS market compared with the nominal Treasury market.

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I underlined one bit I want to emphasize.

Toward the end of the paper, they provide a link to a CSV file with the latest available model values:

The latest estimates will be posted as a comma-separated values (CSV) file at the URL https://www.federalreserve.gov/econres/ ... pdates.csv. As of this publication, daily data are available for the period from January 3, 1983 to July 31, 2026.

I download this to a spreadsheet, filter to only include dates for which both premiums are available, create another sheet that shows just monthly data, and create this chart for the 10Y data:



The chart shows the elevated TIPS liquidity premium in the early years of TIPS, and during the 2008 liquidity crunch, as the authors mentioned in the bit I underlined above.

Note that the liquidity premium tends to dominate, being much more volatile, with much large swings in magnitude.

The latest figures, for Jul 31, 2026, are 0.11 and 0.44 percentage points for the inflation risk and TIPS liquidity premiums respectively.

To the extent the model reflects reality, the liquidity premium is pushing the 10Y TIPS yield up more than the inflation risk premium is pushing the nominal yield up, so the net effect is that BEI understating expected inflation by 0.44 - 0.11 = 0.33 percentage points.
We can rewrite this equation from above:

BEI = expected inflation + inflation risk premium – TIPS liquidity premium

so that expected inflation is the dependent variable:

expected inflation = BEI - inflation risk premium + TIPS liquidity premium

The current 10Y BEI, using the Jul 2036 TIPS, is about 2.34%.

expected inflation = 2.34 - 0.11 + 0.44 = 2.67 (%)

Of course no model represents reality perfectly, and there are other models for this, but my point of view is that a model like this gives us a better idea of what's going on than our own speculations. Given the model, it appears that the net effect of the premiums is that expected inflation is somewhat higher than BEI.

As I showed before in this thread, or some other related thread, we can look at a measure of expected inflation compared to BEI for 10Y term:



This also shows expected inflation for Jul as higher than BEI, although the delta is 18 bps compared to 33 bps for the model, but I used current BEI above. My ... shows 10Y BEI of 2.27 percentage points, so that lowers the model expected inflation by about 7 basis points.

I wouldn't put too much weight on the actual numbers, but at least we see that two sources indicate that expected inflation currently is somewhat higher than the BEI.

Finally, seasonal adjustment has minimal impact on the 10Y TIPS, so I think we can pretty much ignore it, understanding that it could impact it by a couple of basis points.

Statistics: Posted by Kevin M — Fri Aug 21, 2026 1:59 pm