By: Russ Kamp, Managing Director, Ryan ALM, Inc.
As I suspect that you do, I continue to read comments from pundits and industry “experts” claiming that the US is going to be driven into a recession through the Fed’s action of raising rates as dramatically as they have in an attempt to thwart inflation. Investors rightfully continue to focus on the war in Ukraine, inflation, Covid-19’s disruptions, and US interest rates, which some are calling high. First, I don’t think that we are close to seeing a top in rates, and most members of the Fed’s governing board would agree. Furthermore, I would definitely not refer to current US interest rates as high.
The current investment community’s perception has been tainted by four decades of falling rates and low inflation. Just how much economic activity will be reduced by US interest rates that remain well below historic averages? As of trading this morning, the US 3-year Treasury Note has the highest yield at 4.33% (8:56 am) among key rates along the Treasury yield curve. Sure, we haven’t had a 4% yield on this note since 2007, but this level is not high by any stretch of the imagination. As the chart below depicts, rates have been substantially greater, and they occurred during periods of exceptional economic and stock market performance.
The chart above highlights the yield on the 3-year Treasury note during the go-go ’90s. The average yield during that decade was 5.98%, a 1.6% premium to today’s yield. The ’90s was also one of the greatest periods ever experienced by the S&P 500 producing a >18% annual return. GDP growth averaged 3.3% during the same time frame. Clearly, a nearly 6% 3-year Treasury Note did little to tamp down US economic growth during the ’90s. Do we really believe that the Fed has gotten to a level of rates that would dramatically impact US growth, inflation, employment, etc.?
US pension plan sponsors have been on average more responsible than their peers in the UK with regard to the use of leverage. But it doesn’t mean that pension systems here aren’t getting walloped, as domestic equities, US bonds, real estate, and other asset classes dramatically underperform annual objectives. We begged you to take some risk off the table last year following the great market performance. You still have the opportunity to take advantage of the recent rise in rates by transitioning your current fixed income exposure from a return-seeking mandate to a cash flow matching strategy that funds benefits and expenses while the remainder of the fund’s assets buy time to recoup current shortfalls.
Markets may have rallied following the 2000-2002 and 2007-2009 market corrections, but contribution costs skyrocketed and they haven’t fallen back to Earth. A market correction greater than the one that we’ve experienced so far in 2022 could permanently impair pension America’s ability to salvage these incredibly important programs. Let’s NOT let that happen!