I read a article where the author used the difference the between yields of 5 year Tips and 2 year Tips as a proxy of the inflation expectation. Could anyone explain me what is the logic behind this approach. Thanks.
In short, the author is using the difference in yields between 5 year Tips and 2 year Tips as a proxy for inflation expectations. The logic behind this approach is that, in general, longer-term bonds will have higher yields than shorter-term bonds. This is because investors require a higher return in order to compensate for the greater risk associated with longer-term investments. However, if inflation expectations are high, then investors will demand an even higher return on their investment in order to protect the purchasing power of their money. As a result, the yield on longer-term bonds will increase at a faster rate than the yield on shorter-term bonds, resulting in a widening of the yield spread.