Authored by Simon White, Bloomberg macro strategist,

TIPS continue to mean revert and risk overshooting to the downside, leading to a continuation in rising real yields.

Real yields in the US have had a remarkably good run, with 10-year reals bottoming at about 1.72% at the end of March and rising to near 20-year highs at 2.43% currently. That’s even more remarkable when you consider that oil has on net risen almost 70% over the same period.

TIPS were overbought coming into the Iran war, but are now back to their mean. As the chart below shows, TIPS’ annual return is a mean-reverting series, with a decaying mean. Like a pendulum, when the series gets back to its mean it typically overshoots.

If that was to recur, then we should expect real yields to keep rising.

That is consistent with the message from my leading indicator for real yields. Its inputs include G10 excess liquidity and the Federal Reserve’s policy rate, and it anticipates the 10-year real yield rising more over the next three months or so.

Short positioning in TIPS looks elevated, based on the short interest of the iShares TIP ETF. We’re not likely to see significant short covering while momentum is in the bears’ favour.

In shares terms, the short interest is not as high as it was during the inflation flare of 2021/22 and subsequent rapid Fed tightening, but the short interest ratio, ie normalised by the shares outstanding, is at a similar level to what it was back then.

There are different drivers this time. Fed pricing is not as big a part of it, with only two and a bit rate hikes expected over the next year. Instead it’s a combination of rising real growth expectations and greater competition for capital, driven by the seemingly insatiable demand for investment in AI infrastructure.

A good slug of the rise in real yields this year, however, also comes from increasing risk premium for TIPS. No wonder short positioning is high.