Reuters: Pension funds may see the silver lining on the interest rate cloud

26 June 2013

The global markets quake suggests little positive in a rising interest rate environment but the flip side is significant relief for pension funds that may itself provide a stabilising mechanism into the bargain.

Bonds, equities and emerging markets have all lunged violently since the US Federal Reserve last month started signalling a timeline for a reduction in its latest bond-buying programme, in what some see as the beginning of the end of its four-year-old policy of quantitative easing.

Hyper-sensitive to a big turning point in the US monetary policy cycle, benchmark 10-year Treasury yields have jumped up to a full percentage point - to more than 2.5 per cent - since the first week in May - pushing up long-term interest rates across the globe and puncturing buoyant world equity.

This, of course, could be an overreaction by short-term markets. With little change of economic information and only minor tweaks to policy guidance, they have lurched within weeks from the euphoria of endlessly cheap money to conjuring up the gloom of ever-spiralling interest rates. Yet a much more direct positive from higher interest rates, comes via the impact on savers - and final salary pension funds in particular where average liabilities have in recent years been far higher than the assets in those funds.

According to JPMorgan, the bond selloff to the end of May alone pushed the accounting deficits of US and UK "defined benefit" or final salary pension funds to their lowest since 2011. The subsequent rise in yields this month - another 40 basis points on 10-year Treasuries for example - will have helped further, outweighing the drop in equities. And crucially, assuming asset prices such as equities hold steady from here, they reckoned defined benefit deficits would again be fully covered with a further increase of about 80-90 basis point in yields in the UK and slightly less in the US.

As yields rise, the more nimble pension funds - who remain innately risk-averse into peak retirement periods over the next 10 years amid considerable regulatory and sponsor pressure to better match their liabilities - will likely buy even more bonds to quickly lock into higher long-term rates.

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