The bond sell-off is about real yields, not inflation

What moved the 10-year yield, 25 Aug to 24 Sep, bp

What moved the 10-year yield, 25 Aug to 24 Sep, bp. Source: US Treasury and FRED, St. Louis Fed.

Real yield	+53bp
Breakeven inflation	+1bp
10-year yield	+54bp

Source: US Treasury and FRED, St. Louis Fed.The Macro Notebook

The 10-year Treasury yield rose 54 basis points between 25 August and 24 September, to 5.18%, its highest close since July 2007. Almost all of it came from the real yield on inflation-protected bonds, up 53 points to 2.85%. The 10-year breakeven, the market price of inflation, moved one point, to 2.33%.

That is easy to miss in a month of dear oil and a Fed rate increase. Investors are not asking for more protection against inflation. They are asking for a higher return after inflation.

How the split works

A 10-year Treasury note pays a fixed rate. A 10-year inflation-protected note, or TIPS, pays a rate on top of inflation, so its yield is a real yield. The difference between the two is the breakeven: the inflation rate at which both notes would earn the same. When the breakeven holds still and the ordinary yield rises, the whole move is in the real yield. On 24 September the ordinary note yielded 5.18% and the TIPS 2.85%, so the breakeven was 2.33%.

Seven months of the same pattern

The pattern did not start in August. On 27 February, the 10-year yield was 3.97%, the real yield 1.72% and the breakeven 2.25%. By 24 September the 10-year yield had risen 121 basis points. The real yield rose 113 and the breakeven 8.

The breakeven did move in the spring. It reached 2.50% on 4 May, as consumer price inflation headed for its peak of 4.2% in May, and it was back at 2.18% by 24 June. The 5-year breakeven went further, to 2.72% on 4 May, and was 2.33% on 28 September. The 5-year, 5-year forward rate, a gauge of the inflation that the market expects for the five years from 2031, was 2.35% on 28 September, against 2.33% on 25 August.

The real yield kept going up. At 2.85% on 24 September it was the highest since November 2008, and Treasury’s daily real yields put it at 2.90% on 28 September.

Why real yields are rising

The simplest reading is that the market expects the Fed to keep rates high. The Fed raised its target range to 3.75% to 4% on 16 September. The median official expects one more increase this year, and a rate of 4.1% at the end of 2027. Futures lean the same way: on 28 September, CME FedWatch put the chance of another increase in October at 70.9%.

A model from the New York Fed supports that reading. The ACM model splits the 10-year yield into the expected path of short-term rates and a term premium, the extra return that investors ask for to hold a long bond. Between 25 August and 24 September, its expected-rates part rose 45 basis points, and its term premium did not rise. Since 27 February, the expected-rates part has risen 98 basis points and the term premium 13.

Model estimates are rough, but this one points the same way as the breakevens. The market expects a tighter Fed. It does not expect a bond market in trouble, and it does not expect lasting inflation.

Why it matters

Flat breakevens are good news for the Fed. They say that the market expects the energy shock to fade and not to become lasting inflation, and that it believes the Fed will act if it does.

High real yields are the price of that belief. A real yield near 3% raises the true cost of borrowing for companies and home buyers, and it raises the rate used to value shares. So far the S&P 500 has barely noticed. If real yields stay this high, that calm will be tested.