Seasonality In Breakevens
There is some seasonality within the breakeven inflation rate, because the inflation measure used in TIPS is not seasonally adjusted. An important consequence of this is that breakeven inflation rates have a tendency to “peak and trough” around the same time each year.
To identify a potential rotation signal, we evaluated a simple trigger that would signal when it would be appropriate to rotate between the two assets based on the level of the breakeven rate. We collected the closing level of the 10-year breakeven rate for each day going back five years. The chart below illustrates the breakeven rate over time, as well as the average level.
For any day that the current breakeven rate was more than one standard deviation above or below the average, we calculated the return variance between intermediate- to long-dated Treasurys and TIPS three months later.
For observations where the breakeven rate was at least 1 standard deviation below the average, TIPS outperformed Treasurys by more than 1 percentage point over the next three months, with the TIPS outperforming more than 80 percent of the time.
Similarly, when the current breakeven rate was more than 1 standard deviation above the average, Treasurys outperformed TIPS by slightly more than 1.0 percent, over the next three months, with Treasurys outperforming just under 80 percent of the time.