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Why are TIPS yields negative out to 20+ years? People are willing to lock in a loss versus CPI inflation in order to avoid a possibly larger loss.

Why do some people continue to invest in money market funds, bank deposits, savings accounts, when inflation is running at 2%+/year? They are willing to lock in a loss versus inflation in order to avoid a possibly larger loss.

When the Fed adopts aggressive strategies, people will have two responses:

  1. “Yields on safe investments are too low. I need more income. I guess I have to take more risk.”
  2. “Policy is abnormal, and I am scared. I know I am going to lose here, but I want to lose as little as possible. TIPS, bank deposits, and money market funds make sense here. Maybe some gold as well.”

The Fed is counting on response #1, but response #2 is much more common than they would like. Now, response #1 is nothing all that great - the Fed is trying to extract value out of economic actors by making them undervalue risks, whether those risks are duration, convexity, credit, etc. When they encourage more risk, they are trying to extract economic wherewithal out of those that invest there. Who is the one that buys when things are hot, before they are not? That is the target.

So be wary amid the efforts to “stimulate” the economy. When an economy is heavily indebted, stimulus does not work. Far better to invest your money in areas where stimulus does not play a role. Look for healthy places in the economy that do not rely closely on the government.

Finally, don’t take minor changes by the Fed too seriously. They are utterly convinced of their “super powers,” and do not appreciate how little control they have. Every action of the Fed in their “stimulus” has produced progressively less response.

The Fed does not control the U.S. economy. They are codependent with it, and they do not act, they react. The FOMC is hopelessly lost, with a cast of C+ students running the show - people who can’t think more broadly than the failed ideas of neoclassical economics. As I have said before, the FOMC needs more historians, and no neoclassical economists. Bring in the Austrians, they might solve things. You might get a depression in the short run, but afterwards, things would be normal.

That’s why some would rather lock in a smaller loss; this situation is volatile enough that many will want to do so. As for me, I will try to buy undervalued companies, and make money there.

Source: Locking In A Smaller Loss