What were the key issues for pension funds in Q2 2024?
US pensionWatch
The growing role of systematic fixed income
It happened again
PHIL, THE HANGOVER II
We believe investors need to be prepared for an extended period of higher rates as inflation makes its slow journey back to the Fed’s target. We see recession risks as still finely balanced, and believe credit investors need to be diligent, cautious and ready for volatility. In our last quarterly we discussed the topic of the Fed “tightening until something breaks”, and it increasingly appears that, from an international perspective at least, the US dollar may prove to be the catalyst for the “break”. Fed policy has helped drive the US dollar to levels unseen since the Volcker era, a significant problem for other global central banks.
After a four-decade trend of falling rates on a secular basis, the Fed Funds rate is back above the peak that occurred in the previous hiking cycle (in December 2018). This the first time this has happened since 2000 (where rates rose slightly more than they did in the mid-90s). However, it is clear the Fed is not done. Markets are priced for rates to continue rising to a peak of around 4.75% in mid-2023, before declining. Although markets are searching for a dovish pivot, in our view the pivot, when it comes, will simply be to a less hawkish tone, and that rates will plateau through 2023 rather than being cut.
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We highlight the growing importance of systematic approaches in fixed income
market, especially over the last two years. Systematic solutions have a number of advantages over traditional approaches, improving liquidity and with the potential to reduce trading costs.
01. key macro view:
Funding status of largest plans declined in 2023
02. pension news:
In its analysis of the 100 US corporates with the largest defined benefit pension plans, Milliman found that over 2023 funded status decreased from 99.4% to 98.5%. This stands in contrast to our own pension indices which indicated a strong improvement in funding for typical pension plans.
ADVANTAGES OF US CREDIT OVER US CORPS
03. credit:
We outline the potential benefits that can be brought to a corporate bond portfolio by expanding the opportunity set to include US credit. This includes the potential for additional diversification, access to credits with a stronger credit profile, comparable absolute yields and potentially higher risk-adjusted returns.
Fallen angels could be the sweet spot
04. INVESTMENT outlook:
Although the absolute yields available in investment grade and high yield credit are attractive, there is no denying that spreads have tightened and the potential for further tightening appears limited. We look at the potential for fallen angels to be the sweet spot in the current corporate universe – offering higher spreads and outright yields than both BBB and BB-rated bonds.
Adjusting to the end of the low rate era
05. key risks:
Although the interest rate cycle is in the process of turning, we believe central banks will be operating in higher ranges going forward, with the era of low rates at an end. It is unclear if this has been fully priced into asset prices more broadly. The war in Europe continues to be a concern, and there is a risk that events escalate with unexpected consequences. Broader geopolitical tensions are elevated, and tensions between the US and China risk an increasingly polarized world.
The AI Awakening
06. education:
We ask Erik Brynjolfsson, expert in artificial intelligence, to outline his thoughts on how this technology will impact the world in the years ahead. Erik believes the next 10 years could be the best in human history so far, but it could also be the worst should cyber security protocols and regulation fail to evolve appropriately to recognize the threats associated with bad actors.
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