# Block 013 — Breakeven inflation decomposition

**Status:** ✓ done
**Phase:** Phase 1 (Rates)
**Closed:** 2026-07-09 (Session 20)

## Topic scope

Three components of 10y breakeven: inflation expectations + inflation risk premium + liquidity premium. TIPS-Treasury basis. D'Amico-Kim-Wei inflation risk premium paper. Cross-block tie to Block 011 (MBS basis) and Block 012 (SOFR-OIS funding) as the third leg of the rates-microstructure signal layer.

## Plan

**Prerequisite:** Block 00a (rubric), Block 00b (anti-patterns). TIPS-vs-Treasury trade construction.

## Carry-forward to next block

**Pre-block activity (Session 20):**
- 1 FRED-vocab teach (T10YIE/DFII10/T5YIFR definitions + the T5YIFR formula): user requested teach over probe on pre-read #3 (FRED methodology pages not done). Substrate from DKW + Hull Ch. 5 was intact.
- 1 DKW substrate probe (Q3 — three components of breakeven): user named them correctly (expected inflation, IRP, liquidity premium).
- 1 liquidity-premium sign-convention probe (Q4): user articulated the chain — less liquid → higher required yield → lower TIPS price → measured T10YIE understates true breakeven → LP positive. Locked.
- 1 live-data exercise: pulled T10YIE 2.25%, T5YIFR 2.19%, DFII10 2.30%, DFII30 2.79% (2026-07-07). 10y nominal implied 4.55%, 30y nominal implied ~5.09%.
- 1 trade-implication probe (Q6 — 10s30s flattener): user chose the 10s30s flattener as the cleanest expression of the long-end richening view, correctly distinguishing it from the long-TIPS/short-nominal breakeven trade (liquidity-contaminated) and the short-MBS-basis trade (mortgage-market-specific noise). Locked.
- 1 cold-recall reverse (Q7 — signal-layer read on parallel-shift scenario): user partially right with two precision gaps corrected — parallel shift is not "regime change" (would require convex breakeven curve), and the trade key-risk is breakeven reversion not continuation.

**Main material delivered (4 concepts):**
- **Why the decomposition matters — the naive read failure mode:** T10YIE ≠ "what the market expects inflation to be." DKW show ~80-150bp wedge from expectations. A 2.30% T10YIE is mis-read by a full point if you treat it as expected inflation.
- **Three components separately:** Expected inflation (~60-100bp at 10y in 2010s DKW estimate), IRP (~30-80bp, varies with inflation uncertainty), liquidity premium (~30-50bp historical, compressed post-2010s).
- **Cross-block tie (rates-microstructure signal layer):** Block 011 (MBS basis) + Block 012 (SOFR-OIS funding) + Block 013 (breakeven) = three legs of a coherent rates view. Live-data tie: SOFR 3.62% (Block 012 deferred exercise run in this session) + T10YIE 2.25% + current-coupon MBS ~5.58% (Block 011) = +102bp net carry on the basis trade before convexity bleed, no funding stress (SOFR-OIS ~0bp), re-anchoring breakeven.
- **Live-data exercise + on-the-fly correction:** user reported DFII30 as 2.84% — corrected to 2.79% (FRED, 5bp miss). Surgical correction; user's direction-of-read correct.

**Live-data exercise (Block 012 deferred, run in this session's tail):**
- SOFR 3.62% (2026-07-07, NY Fed, vol $3.154T, normal distribution 3.60-3.67%)
- 30-day avg SOFR 3.636%, 90-day avg SOFR 3.635% (FRED SOFR30DAYAVG, SOFR90DAYAVG)
- 30d OIS ≈ 30d avg SOFR ≈ 3.636% (since 30d OIS = compounded SOFR over 30d)
- **SOFR-OIS basis = ~0bp at 30d** (normal regime; historical stress: 2008 350bp+, March 2020 130bp+)
- **No repo specials** (1st percentile at 3.58% = 4bp concession, not a special)
- Block 011 basis carry: trade leg +103bp (5.58% MBS - 4.55% matched Treasury), funding leg -1bp (repo at SOFR 3.62%, term SOFR 3.635%), **net carry +102bp** before convexity bleed

**Anki cards generated (Session 20):** 6 atomic cards. Pushed via AnkiConnect + synced + verified (6/6 findCards). Tags: `block-013 breakeven dkw t10yie t5yifr` + `rates`. Note IDs: 1783599647968 → 1783599648093.

**Status transitions:**
- **Rates — DKW three-component decomposition (NEW):** Untested → **Working** (Q3 substrate clean, components named correctly)
- **Rates — FRED breakeven series (T10YIE/T5YIFR/DFII10/DFII30) (NEW):** Untested → **Working** (definitions, T5YIFR forward construction, mechanical difference between T10YIE and DFII10 — taught in-session, all clean)
- **Rates — Liquidity premium sign convention (NEW):** Untested → **Working+** (Q4 chain articulated — less liquid → bid yield higher → measured T10YIE understates true breakeven → LP positive correction; precision locked)
- **Rates — Cross-block signal-layer discipline (NEW):** Untested → **Working** (Q6 trade-implication probe: clean choice of 10s30s flattener over long-TIPS/short-nominal and short-MBS-basis, with correct rationale for each rejection)

**Pre-block signal-layer live-data tie (deferred Block 012 exercise completed):**
- SOFR 3.62% + term SOFR 3.635% + 30d OIS 3.636% = funding leg of Block 011 basis trade is ~flat (SOFR-OIS at 0bp = no funding stress premium)
- This means the +102bp net carry on the basis trade is real, not an artifact of cheap funding — the trade gets full carry
- T10YIE 2.25% / T5YIFR 2.19% = re-anchoring (T5YIFR closer to Fed's 2% target than T10YIE 10y spot)
- The three blocks now share a coherent read: positive carry, no funding stress, re-anchoring breakeven, real yields elevated but compressing

**Process changes filed this session:**
- **2026-07-09 — Probe-vs-teach default for partial pre-reads (Session 20, Block 013 pre-read #3):** when a pre-read is not done, the user can request a teach-over-probe on the missing piece. Default is still probe-form, but teach is acceptable when the user signals the substrate is missing. Codified in this block's carry-forward and the Block 013 `## Plan` section.
- Pre-read compliance gate worked (verification mechanic, per Session 19): user's "I read 1 and 2" was treated as a partial-read signal, not a pass; specific artifacts (DKW 2014 FEDS revision version) were verified before main material opened. The "yes" → verify-with-specificity mechanic held.

**Post-block practice artifact:** None new. The funding-layer routine from Block 012 (`daily-rates-funding-routine.md`) is the third leg of the rates-microstructure signal layer; no new daily routine needed (per cumulative-time gate, three routines = upper edge of 15-min budget). The three routines (vol, MBS, rates-funding) cover the three signal layers — adding a fourth (breakeven) would exceed the time budget. The breakeven data is already in the rates-funding routine's 8-minute read (so user can fold the T10YIE/T5YIFR/DFII10/DFII30 check into minute 2:30 of the existing routine if desired — option, not required).

**Pre-read for Block 014 (assigned at this session close, per protocol):**
- **Borio et al. (2016) — "FX intervention and the global cycle"** or **Du, Tepper, Verdelhan (2018) — "Deviations from Covered Interest Parity"** — read abstract + intro + Section 2 on the cross-currency basis (~20 min, the canonical "why CIP doesn't hold" paper)
- **Hull Ch. 6 (Interest Rate Futures) — FX futures section** (~10 min, basis mechanics on the futures side)
- **BIS Triennial FX Survey 2022** — read the executive summary on FX market structure, average daily turnover, and the cross-currency basis box (~10 min)
- **FRED series: DTWEXBGS (broad USD index), JPUSGB10Y-Japan 10y, EURUSD, JPYUSD** — bookmark + read methodology (~5 min)
- **Skip:** detailed FX-options carry trade mechanics (Block 057, Phase 2 instrument dossier). Skip: full DTV-Verdelhan appendix. Skip: emerging-market FX basis (different drivers, out of Block 014 scope).

**Total: ~45 min, [thematic].** Source: this close.

**Pointer:** `_meta/current-block.md` updated. Block 013 → done. Block 014 → current.