Even as politicians like President Biden applaud his great economic achievements and Treasury Secretary Janet Yellen dives into Social Security to fund the federal government (just as Biden dives into the Strategic Petroleum Reserve), there are serious problems facing America’s middle class and low-wage workers. Inflation is still brutal (but slowing) and REAL weekly earnings growth has been negative for 21 straight months (meaning Biden’s boast about wage growth has been destroyed by inflation created by his energy policies and their enormous expenses). The annual personal spending rate has plunged -53.5% to cope with inflation. To quote Joe Biden (Chauncy Gardner), “All is well in the garden.” But all is not well in the garden. As a result, we are now seeing pension funds move from stocks to bonds.
(Bloomberg) For some of America’s biggest bond buyers, the hard-or-soft landing debate on Wall Street could be a sideshow. They are preparing to participate with up to a trillion dollars, come what may.
One of the pillars of the trillion-dollar pension fund complex is now awash in cash after struggling with deficits for two decades. This rare surplus in corporate defined benefit plans, thanks to rising interest rates, means they can be reallocated to bonds that are less volatile than stocks, “risk reduction” in industry parlance.
Strategists at Wall Street banks including JPMorgan Chase & Co., Bank of America Corp. and Wells Fargo & Co. say the impact will be far-reaching in what is already being dubbed “the year of the bond.” Judging by the flood of cash in fixed income, they’re just getting started.
“Pensions are in good shape. Now they can essentially immunize: take out stocks, move into bonds and try to match assets to liabilities,” Mike Schumacher, Wells Fargo’s head of macro strategy, said in an interview. “That explains part of the rally in the bond market in the last three or four weeks.”
An irony of pension accounting is that a year like last, with its twin losses in stocks and bonds, can be something of a boon for some benefit plans, whose future costs are a function of interest rates. When rates go up, your liabilities go down and your “cap status” actually improves.
The 100 largest corporate pension plans in the US now enjoy an average funding ratio of about 110%, the highest level in more than two decades, according to the Milliman 100 Pension Funding Index. That’s good news for fund managers who suffered from years of rock-bottom interest rates and were forced to chase returns in the stock market.
Now, they have a chance to correct that imbalance, and the Wall Street banks pretty much agree on how they will use the extra money to do it: by buying bonds and then selling stocks to buy more bonds.
This year, fixed income flows are already outpacing those of equity funds, marking the most lopsided relationship since July.
How much of that is due to derisking pension funds is anyone’s guess. Part of the recent rally in bonds can be attributed to traders covering a slowdown in growth that would hit stocks the hardest.
But what is obvious is their clear preference for long-term fixed income assets that are closest to their long-term liabilities.
Pension funds need to maintain some exposure to equities to boost returns, but that equation is changing.
Once a corporate plan reaches full funding, its goal is often to reduce risk by dumping shares and adding fixed-income assets that align with its liabilities. With the 100 largest corporate defined benefit funds in the US with a cash pile of $133 billion after average yields on corporate debt more than doubled last year, your path is open.
With yields unlikely to top out once the Fed hits its terminal rate of around 5% by mid-year, there has rarely been a better time for them to make the switch to bonds.
Even if growth surprises to the upside and yields rise, causing bonds to underperform, the incentive is still there, said Bruno Braizinha, a strategist at Bank of America.
“At this point and considering where we are in the cycle, the conditions are favorable to reduce risk,” Braizinha said in an interview.
JPMorgan strategist Marko Kolanovic estimates that risk reduction will lead pension administrators to buy up to $1 trillion in bonds; Bank of America’s Braizinha says a $500 billion buying spree is closer to the mark.
How about gold? As the probability of a US debt default looms (as Chucky Schumer’s girlfriend stomps her feet and says “No budget cuts!”) and the US Treasury yield curve. 10Y-3M remains inverted, gold soars.
Perhaps pension funds should use gold instead of cryptocurrencies.
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