The 30-year U.S. Treasury Inflation-Protected Securities (TIPS) yield surpassed 2% on Tuesday, August 15, reaching its highest point since 2011. This follows a significant spike in the 10-year yield, which climbed over 6 basis points to 1.84% on Monday - a record not seen since 2009.

This 2% benchmark for the 30-year real yield hasn't been surpassed since 2011. After that time, the Federal Reserve made substantial rate cuts, and as a result of increasing demands for inflation protection, the 30-year TIPS yield plunged to around -0.50% in 2020 and 2021.

In the past 18 months, the Fed has aggressively raised rates by over 500 basis points to combat inflation. This has made a 2% "real yield" quite appealing for some investors. However, doubts remain about whether U.S. inflation has peaked, and given the growing borrowing needs of the U.S. government, long-term yields might continue to rise.

Many industry insiders view U.S. real yields as an indicator of actual borrowing costs and a barometer for economic outlook. Recent upticks in TIPS and long-term nominal Treasury yields reflect market concerns about future inflation projections.

One pressing issue is that significant increases in real yields could exert notable pressure on asset valuations, necessitating future returns to be discounted at higher rates. Ian Lyngen, Head of U.S. Rates Strategy at BMO Capital Markets, noted in a report that the longer inflation-adjusted borrowing costs remain at such elevated levels, the more significant the impact on corporate and consumer behavior.

Concerns Over Long-Term Treasury Demand

Based on the recently released U.S. government refinancing bond issuance plan, the U.S. Treasury Department auctioned off $103 billion in bonds last week, spanning 3, 10, and 30-year terms. The demand for the 30-year bond was disappointingly low, catching many by surprise.

On August 11, there was an expectation that the 30-year bond auction would go smoothly. Instead, it faced challenges with primary dealers receiving a larger allocation and genuine investment participation being sluggish.

Typically, ultra-long-term bonds like the 30-year variant appeal to specific investors such as pension funds and insurance companies. This 30-year issuance was $2 billion more than the previous one in May. With the U.S. government's massive deficit, the market anticipates this trend to continue.

Some analysts believe the market remains cautious due to the expected vast supply of U.S. bonds in the coming quarter. While not catastrophic, the auction results were far from ideal.

Inflation's Uncertainty

The partial upward pressure on TIPS and long-term nominal U.S. bond yields indicates market unease regarding the unpredictable path of inflation.

Bill Ackman, founder of Pershing Square and dubbed a "Wall Street titan" after his significant earnings during the pandemic, mentioned he's shorting the 30-year U.S. Treasury. Simply put, he believes inflation will remain around 3% long term, a rate surpassing the Fed's target.

Ackman expressed surprise at the sustained low levels of U.S. long-term rates, citing potential factors like deglobalization, increased defense costs, energy transitions, rising welfare costs, and workers having more bargaining power. He would be astonished if we don't find ourselves in a world with consistent 3% inflation.

Are 2% Yields Still Attractive?

Some analysts suggest that for long-term liability-driven investors like pension funds and insurance companies, a 30-year TIPS yield nearing 2% might be too good to resist.

Michael Pond, Head of Global Inflation-Linked Research at Barclays, mentioned that over the past decade, these investors showed little interest in 30-year TIPS. However, at the 2% threshold, they might re-enter the market.

Rob Waldner, Chief Fixed Income Strategist at Invesco, believes bonds, whether nominal or real, should be held. He points out that nominal growth is slowing, running below nominal rates, and there's a risk with the rapid tightening of current policies; the Fed might be making mistakes.

Many anticipate the U.S. 30-year TIPS issuance scheduled for August 24 to be a significant indicator. During the previous inflation-protected bond auction held on July 20 (10-year TIPS), demand was robust, with a winning yield of 1.495% - the highest for this product since 2010.