What were the key issues for pension funds in Q4 2023?
US pensionWatch
Ten issues that defined the year
The night is darkest just before dawn.
HARVEY DENT, THE DARK KNIGHT, 2008
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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In a volatile year for bond markets, Treasury yields ended the year roughly where they began. Moderating inflation helped provide confidence that rates will be cut in 2024, buoying equity and credit markets, but a headwind for the dollar. Pension funded status improved as growth assets gained.
01. key macro view:
a shock comeback for db
02. pension news:
In an update to its employee benefits, IBM has announced the launch of a new defined benefit pension plan for all US employees, replacing company 401(k) contributions. The largest pension fund for federal government employees announced a shift to a new benchmark for overseas equity investments – excluding investments in China and Hong Kong.
Breaking down the maturity wall myth
03. credit:
As we move into 2024, we examine concerns that credit markets face a maturity wall ahead, with a large amount of issuance needing to be rolled over within a short timeframe. When we look at the high yield market we find no evidence that this is
a meaningful problem in the years ahead and funding costs should change gradually despite the volatility in market rates.
too far, too fast
04. INVESTMENT outlook:
Rate cuts are coming, which should be broadly positive for fixed income assets, but we believe the market has got ahead of itself, and there is now significant scope for disappointment in the months ahead. We believe that any meaningful upward correction in yields as markets shift to price in a more realistic outlook could be a good opportunity to add to positions.
Geopolitics remains a source of uncertainty
05. key risks:
Markets are pricing in an aggressive easing cycle in 2024 and this increases the risk of market volatility if the Fed fail to deliver as expected. 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.
A higher neutral interest rate
06. education:
In our view the neutral level of interest rates – or the level of real interest rates at which central bank policy is neither stimulating or restricting growth – has stepped upwards. This is likely to see major central banks conduct policy in higher ranges in the years ahead. We outline what we believe are the key drivers of this shift.
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And I promise you, the dawn is coming.
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