BreakEven Inflation
If you currently own
bonds, you’ve already made a bet on inflation, whether you know
it or not. Traditional fixedincome investments may not provide the real
return investors need during periods of high inflation. It’s important
to know whether your traditional fixedincome investment breakseven with
inflation.
Breakeven inflation
is the difference between the nominal yield on a fixedrate investment
and the real yield (fixed spread) on an inflationlinked investment of
similar maturity and credit quality. If inflation averages more than the
breakeven, the inflationlinked investment will outperform the fixedrate.
Conversely, if inflation averages below the breakeven, the fixedrate
will outperform the inflationlinked.
Calculation Formula:
Comparable FixedRate
– InflationLinked Real Yield = BreakEven Inflation
Calculation Example:
–
= 
4.00%
5Year CD
1.05% InflationLinked Real Yield
2.95% BreakEven Inflation 
An inflationlinked
investment’s coupon is determined by adding the current rate of
inflation to the real yield. In the example above, the average rate of
inflation would have to be more than 2.95% in order for the inflationlinked
investment to outperform the fixedrate investment. And if inflation averaged
lower than 2.95%, the fixedrate investment would outperform the inflationlinked.
