Inflation expectations are the market's forecast of future inflation rates. They are a critical component of nominal bond yields and a key input to monetary policy decisions.
Breakeven inflation rate: the yield spread between a nominal Treasury and a TIPS of the same maturity. The 10-year breakeven reflects the market's expectation of average annual CPI inflation over the next decade.
Survey-based expectations: the University of Michigan consumer survey and the New York Fed's Survey of Consumer Expectations track household inflation expectations.
Inflation expectations matter for the yield curve because:
Well-anchored expectations (stable around 2%) allow the Fed to adjust policy without triggering self-fulfilling inflation spirals
Rising expectations force the Fed to tighten, pushing up front-end yields and often flattening the curve
Falling expectations (disinflation risk) allow the Fed to ease, typically steepening the curve
The blog post "Is Gold a Stock-Bond Diversifier?" explores how inflation expectations drive asset correlations — when inflation expectations rise, stocks and bonds tend to sell off together (positive correlation), breaking the diversification benefit that characterizes low-inflation environments.
The distinction between expected inflation and the inflation risk premium (extra compensation for inflation uncertainty) is important but hard to disentangle without a model.
Real Yield— The inflation-adjusted yield on a bond, representing the true return to an investor after accounting for purchasing power erosion.
Term Premium— The extra yield investors demand for holding longer-maturity bonds over rolling short-term debt.
Fed Funds Rate— The overnight lending rate set by the Federal Reserve, the primary tool of U.S. monetary policy.
Yield Curve— A line plotting Treasury yields across maturities from 1-month bills to 30-year bonds. The global benchmark for risk-free rates and the term structure of interest rates.