I set up 2FA to use Yubikey hardware keys for a google account, and was then allowed to generated app passwords. No phone number has ever been attached to the account.

I do agree that not allowing app-passwords to be generated without setting up 2FA is coercive and seems hard to justify, and it is plausible that it is being used to push people into attaching their phone numbers to their accounts. If I recall right, the current language for the setup process skews heavily toward phone numbers and does not do a good job of highlighting other (more privacy oriented) alternatives (as may be evidenced at least in the case of OP).