Karishma Vanjani
An unusually large disconnect has appeared in the bond market, showing just how unsettled investors are about inflation in the near term.
Market expectations for inflation over the next two years have ramped up alongside higher oil prices and supply chain disruptions from the Iran war. But inflation expectations for a decade from now remain well-anchored. This dynamic suggests investors think the war won't have a lasting effect on prices -- and that they trust the Federal Reserve to get inflation under control eventually.
That view is captured in the difference between the two-year and 10-year breakeven inflation rates. (These rates are derived from Treasury securities, and essentially predict where inflation will be two and 10 years from now, respectively).
The two-year breakeven was nearly a full percentage point higher than the 10-year on Tuesday. That gap -- 0.9402 percentage points, to be exact -- is more than three times the average for the past five years, and is near levels last seen a year ago, when President Donald Trump's "Liberation Day" tariffs fueled an inflation scare.
There's a "great divide between short-term and long-term inflation expectations," wrote Cameron Dawson, NewEdge Wealth CIO in a post.
Before the Covid-19 pandemic, it was the reverse: Investors expected inflation to be higher the further out in time they went, which meant the gap between the two- and 10-year breakevens was negative. But the differential has been positive since the very tail end of 2020, and has spiked significantly since mid-February. In 2022, Russia's invasion of Ukraine triggered a similar jump in the gap between the two- and 10-year breakevens.
"We are experiencing our second inflation scare within a five-year period, something that hasn't happened in the U.S. since the inflation-riddled 1970s," Gina Martin Adams, chief market strategist at HB Wealth.
The two-year inflation breakeven rate was about 3.3006% on Tuesday, compared with 2.3604% for the 10-year. The Fed's target inflation rate is 2%.
The market is pricing in "U.S. inflation approaching 4% in the coming quarters," Padhraic Garvey, who leads ING's research team for the Americas, told Barron's.
Still, the market is keeping faith in the Fed and its interest-rate policy. A rather stable 10-year breakeven inflation rate proves that -- despite five years of above-target inflation and attacks on the Fed's independence -- investors believe the central bank will keep inflation contained over the long-term. The rate has edged up 0.1035 percentage points since the Iran war broke out, compared with a steeper gain of 0.4837 percentage points gain in the two-year breakeven.
"Arguably if the bond market was truly concerned that a captured Fed would cut rates too much and stoke pernicious and persistent inflation, it is unlikely we would see market-based long-run inflation expectations remain so contained," wrote Dawson.
"We have been joking, 'find someone to believe in you like the bond market believes in the Fed's ability to achieve its inflation target'," she added.
However, the market is uncertain about the central bank's moves in the near term. Higher inflation expectations have evaporated hopes for an interest-rate cut at the central bank's April meeting; 97.4% of investors see Fed keeping rates steady while 2.6% are betting on a hike, the CME FedWatch tool shows.
At the same time, with little clarity on the length of the war, a rate cut is possible down the road. That could be necessary if there's a recession because of higher prices at the pump dragging down consumer spending and business hiring.
In that case, "the Federal Reserve is either cutting rates or preparing to do so," Garvey said.
Write to Karishma Vanjani at karishma.vanjani@dowjones.com.
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
April 07, 2026 15:53 ET (19:53 GMT)
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