(Bloomberg) — Short-term Treasury yields again advancing toward 5% take the spotlight, but another drama is unfolding in a lesser-known corner of the US government bond market.
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The yield on the 30-year Treasury Inflation-Protected Note is about to top 2% for the first time in more than a decade. Whether you got there and where you would stop if there were bond investors on edge.
For some, the 2% “real yield” is a buzz buy after the Federal Reserve’s interest rate increases totaled more than 5 percentage points over the past 18 months. For others, the uncertainty about whether inflation has peaked — along with the US government’s growing borrowing need — means that all kinds of long-term yields may need to be higher.
Treasury inflation-protected securities pay interest on the inflation-adjusted principal amount, so their yield represents a risk-free rate of return. Apart from the effects Fed policy may have on future inflation, it is also a measure of the economy’s expectations.
The 30-year real yield topped 2% in 2011. Meanwhile, it collapsed to levels around -0.50% in 2020 and 2021 after the Fed cut rates and demand for inflation protection rose. A push for higher real yields is looming as a test of investor sentiment.
“Our message is to get into bonds, both nominal and real,” said Rob Waldner, chief fixed income strategist at Invesco. “Nominal growth is slowing down and falling below nominal rates. There is a risk that the Fed is making a mistake because policy is tightening quickly now.”
A 30-year inflation-protected return near 2% may be irresistible to investors with long-term commitments such as pension funds and insurance companies. They’ve had limited interest over the past decade, said Michael Bond, head of global inflation research at Barclays.
At 2%, “that investor base may come back,” Bond said. The auction of the 30-year Treasury Inflation-Protected Notes on Aug. 24 will be “a real test of that.” The recent auction of Treasury inflation-protected notes – a new 10-year maturity – on July 20 attracted very strong demand at a yield of 1.495%, the highest price for the product since 2010.
Some of the upward pressure on TIPS yields – as well as long-term nominal Treasury yields – reflects growing uncertainty about the inflation path. Measured and survey-based inflation expectations eased this week, but crude oil rose to its highest level in the year, and health insurance is expected to start fueling price growth.
Michael Codziel, portfolio manager at Pacific Investment Management, said, “There is a possibility that we need higher real and nominal yields. Our base case is a major slowdown, which leads to a recession and ultimately leads to lower interest rates. But there is a chance we will see more of the inflation premium in Curves that we haven’t seen in a long time.”
Read more: Bond Market Inflation Gauge Shows Doubt About Fed’s Quick Victory
Meanwhile, feelings are taking a beating. The longer the 30-year TIPS yield remains above 1.86%, as investors are expected to support it, “the more likely there is a renewed downward push towards new cycle highs, with a medium-term target for higher 2010 yields in view at 2.28%,” Edward wrote. Acton, strategist at Citigroup Inc., in a note on Friday.
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