Yields could be poised to rise as pension funds are ready to wind down purchases of government and corporate debt by mid-September. Funds are taking advantage of last year’s tax law change that gave them until the middle of September this year to deduct pension contributions at the previous year’s lower tax rate.
“There is a tax advantage for most plans to make a contribution prior to Sept. 15 of this year…saving 14 cents on the dollar,” said Matt McDaniel, a partner with consulting firm Mercer. “Unsurprisingly, a lot of corporations are looking at that and saying: ‘Gee our pension plan is underfunded. Why wouldn’t we accelerate that cash and fund it on a cheaper basis.’ This in turn generates dollars into the pension system that has to go to work.”
Pension funds have thus been on a bond-buying spree, particularly during spring and summer, which tamped down yields. Since bond prices are inversely-related to yields, this buying spree would have effectively reduced supply and driven up prices.
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Since the financial crisis in 2008, pension funds have been in a risk-off mode, foregoing the stock market in favor of safer assets like government debt and investment-grade corporate bonds.
“They’re making these decisions at the same time they have a desire to reduce risk. ‘Buying long Treasurys and long corporate bonds that move in tandem with my pension liabilities are going to reduce my overall financial risk,'” said McDaniel.
The benchmark 10-year yield fell to 2.851 and the 30-year to 3.013, while the 5-year yield rose to 2.729 and the 2-year settled at 2.608 as of 1:00 p.m. ET. Some market experts feel that the pension funds scaling back on bond purchases could send yields as much as 20 basis points higher.
“I think in the near term, we have a very tangible date, which means they’ll probably back away to some degree. I think that weakens the bid (for bonds) for awhile, and maybe they come back if you see equities do well and interest rates go up,” said Michael Schumacher, director rates strategy at Wells Fargo. “They move slowly, but they’re big.”
For more trends in fixed income, visit the Rising Rates Channel.