Why Do Long Term TIPs Have Negative Yields?

Why Do Long Term TIPs Have Negative Yields?

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.

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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 US 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.

By David Merkel, CFA of alephblog

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.