Since last month's inflation-linked bond update, Interactive Data Fixed Income Analytics has implemented a more precise method for estimating implied inflation forecasts from the TIPS market real yield and market nominal yields. The technique constructs an implied market inflation forecast that varies through time, using current single quarter and one year consensus forecasts as a starting point. Long-term market inflation forecasts are determined by current real yields and the current nominal yield curve.

Deriving this time-varying inflation forecast amounts to constructing a complete "zero coupon inflation curve". This can be used, for example, to derive a market estimate of the average rate of inflation over the next 10 years. The graph above shows how this implied market long-term inflation forecast has changed over time. For example, note how inflationary expectations fell from 3.2% to 3% after the release of the employment cost index at the end of April. Ten-year real yields have remained stable while nominal yields have rallied.

The implied market inflation forecast can be subtracted from the Treasury nominal forward curve to obtain a real forward rate curve, providing an estimate of the term structure of real yields. The above graph shows that the estimated real yield curve has steepened since the end of January - this should be contrasted with the nominal yield curve, which has flattened. The explanation is that the "inflation forecast curve" has flattened signifcantly.

A potential application of the analysis would be to generate more accurate valuations of inflation-linked liability streams, and of illiquid assets which generate inflation-linked revenues. Further details on the Interactive Data Fixed Income Analytics analysis of inflation-indexed bonds will appear in a separate research report. We will continue to update the analysis on a daily basis.