Inflation swaps are over-the-counter derivatives in which one party pays a fixed rate and receives realized inflation (typically CPI) over a set tenor. The fixed leg quotes the market's priced inflation expectation, giving a cleaner, real-time read than survey measures or breakevens.
In the dominant zero-coupon form, the inflation buyer pays compounded fixed at maturity and receives the cumulative change in the reference index (US CPI-U, euro-area HICP ex-tobacco). The breakeven fixed rate is the swap's quoted inflation. Comparing one-year against five- and ten-year tenors traces the entire priced inflation curve.
With the long end repricing inflation risk through 2025-2026, swaps let desks separate near-term tariff and energy pass-through (one-year) from anchored medium-term expectations (5y5y forward), isolating whether disinflation is stalling at the front or de-anchoring at the back.
In late 2022, euro-area one-year HICP swaps traded above 7% on the energy shock while the 5y5y forward held near 2.3% — the curve signalling a transitory front-end spike with medium-term expectations still broadly anchored to the ECB's target, a divergence that shaped the 'look-through' debate.
ZCIS payoff at maturity T: floating leg = [CPI(T)/CPI(0) − 1]; fixed leg = (1 + r)^T − 1, where r is the quoted breakeven inflation rate.