Breitbart Business Digest: People Are Worried About the Long Bond

The 30-Year Yield Is Screaming Confidence Not Fear

The yield on the 30-year Treasury climbed above 5.30 percent Monday, its highest level since 2007. This is a testament to the perceived strength of the U.S. economy, although you would never know that reading the financial press.

CNBC attributed the rise to “worries growing among investors about persistent inflation and government borrowing.” A version of that inflation anxiety thesis can be found almost anywhere you look. The ominous historical comparisons came quickly. Last week’s auction produced the highest 30-year borrowing cost since 2001. Monday’s secondary-market yield was the highest in 19 years.

The trouble with the alarming interpretation is that the market is not behaving as though investors are worried about persistent inflation or the government’s ability to finance itself.

Nominal Yields=Inflation Compensation + Real Yields

A standard way of analyzing the nominal Treasury yield is to divide it—or, if you want to sound fancy, decompose it—into two broad components. The first part is the compensation investors require for expected inflation. If they are worried about debt, deficits, overly accommodative monetary policy, or the Fed’s credibility, this component rises. The second part is the real return investors demand for committing their money. This is basically the compensation for the opportunity cost of foregoing other investments or current consumption. When investors think the economy is going to grow at a faster pace and therefore expect other investments, especially stocks, to provide higher returns, they demand higher yields from bonds. We can observe the real return in the market for Treasury Inflation-Protected Securities (TIPS). The principal value of a TIPS rises with the consumer price index (CPI), so its quoted yield represents the return investors receive above inflation.

The difference between the yield on an ordinary Treasury and an inflation-protected Treasury of the same maturity is known as the “breakeven inflation rate.“ It tells us how much inflation compensation investors are demanding.

So here’s how this works. If mounting deficits and debt were causing investors to fear that Washington would inflate away its obligations, the 30-year breakeven should be rising. But it is not. The monthly breakeven was 2.20 percent in July, down from 2.30 percent in May. Since the series began in 2010, its median has been 2.23 percent. The current reading is lower than the 2.55 percent reached in April 2022 and far below the 2.71 percent recorded in 2011.

The daily figures are even more revealing. At the beginning of this year, the nominal 30-year Treasury yielded 4.86 percent, while the 30-year inflation-protected Treasury offered a real yield of 2.63 percent. The difference was 2.23 percent. And since the Fed’s two percent target is based on a metric—the personal consumption expenditures price index—that typically runs slightly below CPI, this suggests investors think the Fed will stay on target. By Friday, the nominal yield had risen 39 basis points to 5.25 percent. The real yield had climbed 37 basis points to three percent. Inflation compensation had increased by just two basis points.

On Monday, when we hit this allegedly scary 19-year high, the breakeven was down to 2.23—slightly lower than what it was on Friday. In other words, nearly the entire increase in the long-bond yield this year has been real. Whatever has changed in the market’s outlook, it is not the expected long-run inflation rate.

The Story Is Boom Not Gloom

The more plausible explanation is that expected real returns on other investments have risen. Investors are expecting the economy to offer more productive investment opportunities. And so they demand a higher return before locking their money into government bonds. Treasury yields are rising because the opportunity cost of owning Treasuries has risen. And the opportunity cost has risen because investors are expecting stronger growth than they were.

One reason this gets so badly misinterpreted by so much of the financial press is that it runs counter to the Trump Derangement Syndrome narratives that dominate their thinking. If you are wedded to the belief that cracking down on illegal immigration and raising tariffs will slow growth, it becomes almost impossible to read the bond market’s signals accurately. If you think that Fed Chairman Kevin Warsh desperately needs to re-establish credibility by explicitly talking about his “reaction function,” rising yields will look like rising inflation expectations. If you don’t think the Trump tax cuts and regulatory rollback spur growth, then you can’t understand why the perceived opportunity cost of holding the long bond would be rising.

But the expectations for more growth make sense once the blinders are taken off. The artificial-intelligence buildout is creating an extraordinary demand for capital. Data centers, semiconductor plants, power generation, transmission equipment, and cooling systems must all be financed. AI-related companies are issuing large quantities of corporate debt because they believe the returns on this investment will exceed the higher cost of borrowing. They understand that much of this build-out will have to happen inside the U.S. because our policies are not going to let China-based AI become dominant in our economy.

A rise in real yields is exactly what we should expect from an economy in which capital has become more productive and businesses have found profitable new uses for it. The higher yield is the market price required to pull money away from those opportunities and back into government securities.

The long bond is not warning that inflation is becoming unmoored. It is telling us that the required real return on capital has risen. In an economy undergoing a historic investment boom, that should be unsurprising.

People are worried about the long bond. The long bond appears considerably less worried than they are.