Clearly the global equity markets have been inspired by the announcement from Europe that the ECB will engage in a “QE” program designed to stimulate economic activity in the Eurozone through the purchase of Euro $1.1 trillion in sovereign debt. Given the positive market reaction how might this bond buying program negatively impact US DB plans?
Unfortunately, most consultants and plan sponsors remain fixated on the asset side of the pension equation (ROA as Holy Grail), and given that focus they will be heartened by this news. Well, given the robust rally in the bonds of the Euro participants, in which yields on government debt continue to fall (precipitously) it is highly unlikely that the US Federal Reserve will have much impact on US interest rates in the foreseeable future.
Currently, the US 10-year Treasury is trading at a yield of 1.83%, while the equivalent German and Japan 10-year yield 0.33% and 0.24% (1/23 @ 11:40am). Given the announced purchase of European sovereign debt, those yields are likely to fall further (at least in Germany’s case). As such, the much greater yielding US debt will likely become attractive to foreign investors, further driving down the yields on our government debt.
The present value of US pension plan liabilities will likely continue to grow at a faster pace than the assets given the continuing fall in rates. Since most US DB plans are underweight US fixed Income (at least long duration / high quality bonds), the asset / liability mismatch will continue to create funding problems for pension America. DB plans need to mitigate this risk by focusing more attention on their plan’s liabilities. Just because interest rates appear low based on recent history, there is no guarantee that rates will rise anytime soon. Most DB plans, but especially cities and states, cannot afford the contribution volatility that arises from a plummeting funded status.