22 September 2018

Pension Funds To Buy More Treasurys

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U.S. companies are funneling extra money into their pension funds to take advantage of temporary tax savings, moves that are helping suppress yields on long-term Treasurys.

S&P 500 companies are contributing to pension plans this year at a pace expected to nearly match 2017’s level, which at $63 billion was the most since 2003, according to Goldman Sachs Asset Management. Last year’s contributions were spurred in part by companies anticipating changes in the U.S. tax-code overhaul.

That and continued contributions this year have been a boon for the Treasury market because pension funds tend to invest in long-dated bonds to match their long-term liabilities. The yield on the 30-year bond has been falling recently, closing at 2.953%% on Thursday, down from a recent peak of 3.245% in mid-May.

Analysts are pinning the drop in yields—which happens as prices rise—partly on demand from pension funds. Long-term rates have remained low and U.S. inflation has picked up this year. Inflation poses a risk to bonds, and especially longer-dated ones, because it erodes the purchasing power of fixed-interest and principal payments.

Counting ContributionsU.S. companies made big contributions to their pension funds last year and areexpected to do so again this year.S&P 500 pension contributionsSource: Goldman Sachs Asset ManagementNote: 2018 figure is a full-year estimate

Long-term yields are “very low because people are still putting money into Treasurys,” said Torsten Slok, an economist at Deutsche Bank .The difference between yields on 30- and 10-year Treasury debt has shrunk to about 0.13 percentage point this week from about 0.33 percentage point at the start of this year.

Voluntary contributions to pension funds, which already were brisk last year, have taken off recently thanks to the passage of the tax overhaul. This introduced a window for companies with underfunded plans to make additional contributions and garner a tax benefit, analysts say.

Firms that contribute through mid-September of this year can receive deductions based on the old 35% corporate tax rate, rather than the new 21% rate. A company that contributes $1 million to an underfunded pension plan could have $350,000 in tax savings before the deadline, but would have savings of just $210,000 after September.

Those making discretionary pension contributions include Verizon Communications Inc., which added $1 billion to its pension plan in the first three months of the year, a large enough sum that the telecom giant won’t have to make mandatory contributions for eight years, the company said in April. A Verizon spokesman said the tax benefit was a factor in the contribution.

PepsiCo Inc. said in April that it made a discretionary contribution of $1.4 billion. Deere & Co. and United Parcel Service Inc. both have cited the tax law as the reason for increasing their voluntary pension contributions.

Under the new tax law approved by Congress, the standard deduction is going up and the personal exemption is going away. But these changes won't be visible until your 2019 returns. WSJ's Richard Rubin explains the recipe behind the changes that are coming to your tax bill. (Originally Published February 15, 2018)

“You will probably see more do it over the next few months,” said Michael Moran, a pension strategist for Goldman Sachs Asset Management.

One sign that pensions have a lot of fresh money to pour into U.S. government debt is strong demand for what are called stripped long-term Treasurys. These securities are created when bond dealers cleave a bond into separate interest-only and principal-only instruments.

Pension funds often purchase the principal-only instruments, which are akin to zero-coupon bonds. The funds purchase the debt at a deep discount, forgo regular interest payments and instead receive the debt’s full face value at maturity. This gives pension plans funds when a liability is coming due and provides them with more financial flexibility in the meantime.

The amount of stripped long-term Treasury bonds rose 9.4% in the first five months of 2018, putting them on track to grow at more than twice the pace of the previous year, according to data from BMO Capital Markets. That would mark the fastest growth since 2010.

Stripping SoarsPension funds and other investors who have long-term liabilities to pay for have ledto a surge in demand for stripped Treasurys.Stripped Treasury long-term bondsSource: U.S. Treasury

Pension-fund purchases of both principal-only stripped long-term Treasurys and Treasury debt have played a key role in keeping long-term yields low, analysts said. And pension funds’ debt appetite may grow in coming months as companies that have been waiting for higher rates make their move before the tax window closes, said Richard Sega, chief investment officer at Conning, who manages money for insurance companies and pension funds.

After that, though, pension funds could have a reduced appetite for longer-dated Treasurys. Combined with a quicker pace of government-debt issuance due to growing deficits, this could help to push yields higher, said Deutsche Bank’s Mr. Slok.

Demographic shifts toward an older workforce, though, could lead companies to continue increasing pension-fund contributions. Meanwhile, companies and governments in developed economies outside the U.S. will face similar demographic challenges, which also would lead to more Treasury buying, Mr. Sega said. “This is a long-term global trend,” he said.

Click here for the original article from The Wall Street Journal.  

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