Rising Treasury Rates Spur Pension Funding

Pension funding ratios increased 2.0% in April, spurred on by a combination of rising Treasury rates, and “impressive equity returns,” according to investment advisor Legal & General Investment Management America (LGIMA).

LGIMA estimates the Treasury component increased 14 basis points, while the credit component remained largely unchanged, resulting in the discount rate rising 14 basis points. Overall, liabilities for the average plan were down 1.9%, while plan assets with a traditional 60/40 asset allocation increased 2.0%.

Both domestic and international equity markets posted strong gains during the month, despite persistent volatility from a potential US-China trade war, rising tensions between the US and Russia in Syria, and uncertainty over the Iran nuclear deal.

“Balancing caution with opportunity, investors still experienced positive price action as earning, specifically in the US, exceeded expectations,” said the report. It also said that general confidence remains solid as global growth prospects appear stable, citing China’s strong annual growth while also cutting rates, and lower unemployment in the Eurozone.

“The US is also positioned well, as both manufacturing PMI and consumer confidence surprised on the month,” said the report. “Overall, April performance leaves equities broadly flat year to date.”

The US 10-year rate reached 3.0% for the first time since 2014, as inflation edged higher, and the US Federal Reserve kept its focus on wage growth as the main driver of inflation, which also increased. According to LGIMA, the market sees a 35% chance of a rate hike in May, but has priced in a June hike at a probability of -93%.

“With strong earnings and a positive economic outlook, investors will be focused on developments in geopolitical tensions as a potential catalyst to drive rates higher,” the group said.

While the equities markets and rates market had a positive impact on funding ratios in April, the report said that credit spreads only had a minimal effect during the month. New issuance totaled $109 billion for the month, which was larger than expected in April. The report said there has been a noticeable improvement in demand for credit in the last few weeks from some of the key buyers that were absent during the first quarter of the year.

“One might think that high demand would tighten spreads, but they continue to widen even as earnings continue to surprise to the upside,” said the report. “Part of the problem may be that investors simply don’t believe that the improvement in demand will persist.”