U.S. Inflation Breakeven Curve Fully Inverts as Tariffs Loom

(Bloomberg) -- The U.S. breakeven curve has inverted as investors speculate that tariffs will lead to a near-term pickup in inflation.

The measure of traders’ wagers on cost-of-living increases -- derived from the yield difference on plain-vanilla Treasuries and their inflation-protected counterparts -- fully inverted Wednesday morning for the first time since the end of the financial crisis. That is, two-year breakevens were higher than their five-year peers, which in turn were higher than 10-year maturities. The curve usually slopes upward because investors assume that over time, the risks are skewed more toward an unexpected acceleration in price pressures.

The anomaly comes as U.S. President Donald Trump’s push for tariffs on inbound steel and aluminum escalates the threat of higher consumer prices caused by importers passing on their increased costs for raw materials. Longer-term inflation wagers aren’t keeping up as investors price in the potential for a growing trade war to damp economic growth, which usually takes pressure off consumer prices.

“What the market is saying is that the factors that might cause inflation to pick up -- like for example, tariffs -- are likely to be transitory in nature,” said Michael Pond, the head of global inflation market strategy at Barclays Capital Inc. “These tariffs alone, or if it turns into a broader trade war, could push inflation higher but may slow growth, which would push inflation right back down later.”

A flattening of the breakeven curve is also part of a seasonal pattern, the strategist added, as non-seasonally-adjusted inflation prints tend to run higher in the first half of the year, a dynamic that has an outsized impact on nearer-term inflation-protected securities.

While the breakevens have converged near 2 percent, that doesn’t necessarily imply traders are confident that the U.S. central bank will meet its inflation goal. That’s because the underlying bonds are linked to the U.S. Consumer Price Index, which typically come in higher than the Federal Reserve’s preferred gauge of inflation -- the core Personal Consumption Expenditure Index -- over the past three decades.

“For the inflation risk premium to come back, the market needs to see a bit of above-target inflation that the Fed is willing to accommodate and not fight hard against, and until then pricing of a low if not negative inflation risk premium seems appropriate,” Pond said.

The spread between 30- and 10-year breakeven inflation rates are now fluctuating between positive and negative territory. It’s the second incidence of an inversion this year for that pair; bets that 10-year inflation breakevens will stay hotter than the 30-year tenor have fared poorly, historically.

To contact the reporter on this story: Luke Kawa in New York at lkawa@bloomberg.net.

To contact the editors responsible for this story: Jeremy Herron at jherron8@bloomberg.net, Brendan Walsh, Dave Liedtka

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