Do inflation-linked bonds contain information about future inflation?

• Main Authors: José Valentim Machado Vicente, Osmani Teixeira de Carvalho Guillen
• Format: Article
• Language: English
• Published: Fundação Getúlio Vargas 2013-06-01
• Series: Revista Brasileira de Economia
• Subjects: Inflation-Linked Bonds; Real and Nominal Yields; Term Premia; Break-Even Inflation
• Online Access: http://www.scielo.br/scielo.php?script=sci_arttext&pid=S0034-71402013000200006&lng=en&tlng=en

There is a widespread belief that inflation-linked bonds are a direct source of information about inflation expectations. In this paper we address this issue by analyzing the relationship between break-even inflation (the difference between nominal and real yields) and future inflation. The dataset is extracted from Brazilian Treasury bonds covering the period from April 2005 to April 2011. We find that break-even inflation is an unbiased forecast only of the 3-month and 6-month ahead inflation. For medium horizons (12 and 18 months), break-even inflation has weak explanatory power of future inflation. Over long horizons (24 and 30 months), we report a significant, but counterintuitive, negative relationship between the break-even and realized inflation rates.