Caution, risk aversion, and a lack of confidence have characterized much of the current recovery. So it is not surprising that the demand for money and safe assets has been strong, just as the public’s desire to deleverage has been strong (deleveraging is equivalent to wanting more money and less debt). Savings deposits, despite their near-zero yield, have grown at double-digit rates since 2008. T-bill yields are virtually zero, a sign of extremely strong demand for safe assets. The real yields on TIPS plunged deep into negative territory, as the demand for these default-free and inflation-immune assets proved so strong that investors were willing to accept a guaranteed negative real rate of return. Bond mutual funds have enjoyed exceptionally strong inflows for most of the past four years, while equity mutual funds have suffered massive withdrawals. Household financial asset burdens have declined significantly as households have deleveraged. Gold, the preferred asset for those seeking refuge from inflation, geopolitical risk, and the just-plain-jitters, rose to extraordinary heights over more than a decade, doubtless fueled in part by speculators with access to money at historically low interest rates.
All things considered, it looks to me like the market is over-reacting to the prospect of a tapering of Fed bond purchases. When it does begin tapering, the Fed will be responding in a responsible fashion to the world’s declining demand for safe assets. This is not something to fear, it’s something to cheer.