Rock-bottom global yields challenge future funding for pension stakeholders.
The global bond rally of 2019 has been a boon to investors who own fixed income – but the drop in yields could have unhappy implications for pension plans and those counting on them for future income.
What’s at issue is the continued ability of defined benefit and other types of pensions to generate the income needed to meet future obligations. Many such plans look primarily to the bond market to generate stable streams of income. But as higher-coupon bonds that they hold mature, the equivalent-risk bonds available for reinvestment carry much lower yields. All markets wax and wane, of course, but this year’s rally comes on the heels of over two decades of downward pressure on yields – with little apparent prospect of a reversal soon.
Declining Yields are a Global Challenge
Source: Bloomberg, as of 8/26/2019. Past performance is no guarantee of future results. * Index is Bloomberg Barclays Global Aggregate Bond Index, Yield-to-Worst. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
One year by itself is not that significant – but if low yields continue long enough, pension plans could, like farmers facing prolonged drought, face the choice between eating their seed corn and planting for the future. In the meantime, current conditions serve as a reminder of the value of active fixed-income managers that can look beyond established indexes for opportunity.
On the rise: Eurozone’s debt capacity
While some countries in Europe carry heavy debt burdens, it’s highly unlikely that the International Monetary Fund (IMF) will be asked to bail out the eurozone as a collective entity. One of many reasons is that the eurozone’s overall capacity to absorb debt has continued to improve since the 2011-14 European debt crisis. As measured by the IMF, eurozone government debt as a percent of gross domestic product (GDP) has fallen from 92% at the end of 2014 to a projected 84% at the end of 2019 – and just over 75% by the end of 2024. That’s especially noteworthy given the region’s current sluggish rate of growth, a reflection in part of of the European Central Bank (ECB) policy of deleveraging under past president Mario Draghi. Given the recently renewed commitment of the ECB to resume stimulative monetary policies, that could change – but for now the news is positive.
One useful point of comparison: the IMF’s debt to-GDP ratio of the U.S. is projected to be over 106% at the end of 2019, rising to over 110% by the end of 2024, based on current fiscal and monetary policies.
On the slide: Germany’s borrowing costs
As most of Europe’s interest rates continue to fall, the entirety of Germany’s yield curve is now negative, from one month (-0.6625%) to 30 years (-0.1912%). At the same time, Germany is experiencing an export-led slowdown, with the economy contracting -0.1% in the second quarter, in part due to a reduction in net trade of -0.5 percentage points.
Germany’s surplus for the first half of 2019 came to €45.3 billion, or 2.7% of the country’s GDP. At the same time, Germany has perhaps the lowest cost of borrowing in the world. But given the country’s preference for saving on both a governmental and individual basis, it may take even more than these circumstances to convince Germany to begin a campaign of fiscal stimulus, however funded.
All data Source: Bloomberg as of August 27,2019, unless otherwise specified.
The International Monetary Fund (IMF) is an international organization of various member countries, established to promote international monetary cooperation, exchange stability, and orderly exchange arrangements.
The Bloomberg Barclays Global Aggregate Bond Index is an unmanaged index of global investment-grade fixed-income securities.
Yield-to-Worst is the yield generated assuming a bond is redeemed by the issuer on the least desirable date for the investor. Yield-to-Worst for the asset class is calculated as the weighted average yield to worst of the individual constituent bonds.
The yield curve is the graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities.
Gross Domestic Product ("GDP") is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.
U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.