Breakeven Inflation Rate Funding Opportunities
last updated on Tuesday, February 16, 2021 in Advances
As we enter a new year, it’s time to focus on your balance sheet’s sensitivity to potential shifts in rates and the yield curve. 10-year US Treasuries now sport a handle well above 1.00 percent for the first time since March of 2020. Although standard measures of inflation (e.g. the Consumer Price Index and Personal Consumption Expenditures) congregated around the 1.50 percent level during 2020, with money supply rising by approximately 25 percent during the last nine months, it may be an opportune time to recalibrate inflationary expectations.
Markets represent a proxy to inflationary expectations. For instance, the difference between Treasury Inflation-Protected Bonds (TIPS) and their counterpart Treasury yields are at their widest spreads since June of 2018. The spread, now well above 2.00 percent, currently assumes that the 5-year Treasury note with a yield of 0.49 percent versus a negative 1.81 percent yield on 5-year inflation-protected Treasury notes. This spread, known as the “break-even” inflation rate, implies that if actual inflation is higher than the break-even rate, in this case, 2.30 percent, an investor would be better off owning these inflation-adjusted Treasuries than they would be in the case of standard 5-year Treasuries.
Shifting inflationary estimates prompt the assessment of so-called “bear-steepener” scenarios. While many members have been historically asset-sensitive, meaning that their assets are re-pricing more frequently than their funding, there’s good reason to believe that many institutions are not as asset-sensitive as they were a year ago.
Why? Many have been:
- Reaching out on the yield curve for higher investment returns,
- Witnessing customers asking for longer loan maturities and
- Facing diminished non-maturity deposit durations in an excess liquidity environment.
5-Year Breakeven Inflation Rate (January 2016 – January 2021)
Source: Federal Reserve Bank of St. Louis Economic Research, February 8, 2021
With markets expecting inflation to be over 2.00 percent over the next three-to-five years, with corresponding promotional three-year and five-year advances being offered in the respective ranges of 46 and 78 basis points, (not including adjusting for receiving a 5.50% cash activity stock dividend, resulting in a further approximate reduction to the net cost of borrowing, netting 24 and 56 basis points, respectively) advances are being priced through inflation by a wide margin; meaning that members may effectively borrow at negative expected real interest rates. Now is an opportune time to lock in funding at expected negative real yields!
Talk to your relationship manager for more information.
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