The real yield is calculated by subtracting the breakeven rate from the nominal rate. The breakeven rate is supposed to be the market’s inflation estimate and the nominal rate is what you often see cited by the media. The interplay between each yield is dynamic. It’s not as simple to say the real yield is determined by inflation expectations and the nominal rate because the real yield impacts them too.

In the past few months, the nominal rate has risen because of the rise in inflation expectations, while the real rate or the TIPS (Treasury Inflation Protected Securities) has gone deeply negative. With the breakeven rate rising so much, the nominal rate would be rallying more if it wasn’t for the low TIPS yield. On the other hand, with the breakeven rate towards the high end of its historical range going back to 2003, it doesn’t seem like the nominal rate has much more room to rise if the real yield stays this low.

Think about it this way. The 10 year breakeven rate is at 2.21%. Say it rises to 2.77% which would be the highest rate since inception. That only gives the 10 year yield 56 basis points more room to the upside. There’s not a lot of room left to the upside if you think it might peak a little lower. The 10 year yield has already increased about 90 basis points since its low last year.

Real Yields Drive ‘Risk On’

With the breakeven rate so much higher than the nominal rate, investors are getting a negative return for holding treasuries to maturity. Of course, you can make a profit by trading them. We think reaching a negative nominal yield is immaterial if the yield is already negative in real terms. With the rise in inflation and the decrease in corporate bond yields, their real rate has also gone negative.