Read on Twitter
people should really focus on the TIPS curve not the break-even curve. the break-even is simply a residual and would only be meaningful if the markets were comparable in size and liquidity AND if the indifference map of aggregate participants ICs was reliably convex...
in a theoretical world BEs matter because investors can "arbitrage" the difference by buying or selling TIPS vs nominals and realizing the difference between CPI and the BE. In the real world the volatility would limit your ability to leverage it enough to make the trade economic
but there's still less-strict market forces that pressure market based measures of inflation compensation (BEs) towards ~inflation expectations~, like when real-money chooses to allocate to TIPS instead of nominals or vice versa, the real-money indifference curve is "rational"
and to a certain extent it works on the short-end where the trade-offs of picking one asset over the other are quickly materialized. however bonds are not just bought as sources of interest, they are also act as sources of price volatility and potential liquidity
that's why you see spreads between AAA MMMF-eligible ABS, FDIC-insured brokered deposits (think CDs and some structured notes), and bills and short term notes. short treasuries are bonds, sure, but they also effectively function as ~money. and TIPS are less moneyish than nominals
on the long end you have a similar dynamic. long-term TIPS are wayyy less price-volatile than long-term tsy bonds. You might think that's good but it's not always, there is A LOT of money that buys long bonds only for portfolio utility & leverage. they want maximum px volatility
likewise, there are some actors who have liabilities that are tied to CPI and (think of COLAs) if you want to remove that risk directly from your balance sheet in a clean way your only option is TIPS. and if a lot of people are doing that in a smallish market, it can be expensive
lastly... remember that the break even of the on-the-run curve is the price of a European-style option** on annualized realized inflation struck at 0% and as such is a function of both it's expected value AND the premium paid for that option. it's more a deep ITM option than swap
** TIPS compensate the owner for inflation by factoring up (or down in the case of deflation). there's a multiplier that's 1.0 at-issuance that changes in as CPI changes. The principal amount of the bond is the face value times the factor. That multiplier is floored at 1.0.
that means that--while you can never lose principal in a new-issue security held to maturity--if you own an off the run security with a factor above 1.0 a period of deflation would adversely affect the value of your principal. that's why off the run TIPS can have very diff yields
anyways I am hungry and to be honest in a well-functioning economy 99% of you wouldn't need to know any of this or what break-evens are. anyways.... ignore break-evens, they really don't mean all that much, especially not when aggregated indiscriminately into curves
