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U.S. Treasury yield curve flattening to intensify with U.S. pension plan bond-buying

U.S. Treasury yield curve flattening to intensify with U.S. pension plan bond-buying

NEW YORK (Reuters) – Corporate pensions are shifting a chunk of their $1.55 trillion in assets into fixed income, which may be sizeable enough to flatten the yield curve further.

The funding gap, between what corporations owe in pension plan obligations and their assets, narrowed by $72.4 billion last year as the U.S. stock market rallied and companies from Boeing Co to Verizon Communications Inc made multi-billion dollar contributions, according to a new study by Seattle-based consultants, Milliman, Inc.

But as funding improves, pensions reduce their portfolio risk, reallocating assets from equities into long-duration debt, driving up demand for corporate bonds and 10- and 30-year U.S. Treasuries.

The likely sizeable shift in $1.55 trillion of pension fund assets may raise bond prices enough to tamp down the long end of the yield curve, reducing the difference between long and short term debt yields.

The move may have already begun. Demand from pension funds and insurance companies “is part of the reason we have seen a fairly aggressive flattening of the yield curve over the last six-12 months,” said Neil Sutherland, fixed income portfolio manager at Schroders.

On Tuesday, the 10-year Treasury yield broke the psychologically important yield level of 3.0 percent, but the curve remains significantly flatter than it was at the start of 2018. The difference between U.S. 5-year notes and the 30-year long bond yield for example was around 0.38 percentage points on Wednesday, compared to 0.51 percentage points on Jan. 2.

There are a range of estimates about how much money exactly will be going into fixed income. U.S. corporate pension plans could purchase around $150 billion in high-quality, long-duration fixed income each year for the next several, according to Michael Moran, chief pension strategist at Goldman Sachs Asset Management.

More than half of the total return gains pension funds made in 2017 could be invested in the fixed-income market, said Louis Finney, executive director of asset allocation on the Investment Solutions team at UBS Global Asset Management. Last year, the ratio of funding to obligations at the 100 largest U.S. corporate pensions rose to 86 percent, a 5 percentage point jump that is worth $72.4 billion, according to Milliman.

That means half of that, or $36.2 billion, could be put to work in long-duration bonds.

Another factor that could boost demand for long-duration bond prices is the $34 billion in contributions employers plan to make before September, after which tax deductions will have to be taken at the new lower rate under the tax reform law passed by the U.S. Congress last year.

Corporate bonds are pension funds’ first pick for fixed-income investment, but low supply may drive them further into the U.S. Treasury market. Around $165 billion of 30-year high-quality corporate bonds are issued a year, according to Moran.

As U.S. companies with foreign earnings repatriate cash, after the tax law changes last year, there may be less need to issue new corporate debt. With pension demand averaging around $150 billion, “it could lead to a bit of a food fight for these bonds,” Moran said.

Reporting by Kate Duguid; Editing by Jennifer Ablan and Clive McKeef

Published at Wed, 25 Apr 2018 18:40:54 +0000

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Rate Trigger

Rate Trigger

WHAT IS ‘Rate Trigger’

A rate trigger is a drop in interest rates significant enough to cause a bond issuer to call its bonds prior to maturity.

BREAKING DOWN ‘Rate Trigger’

A rate trigger is a decline in prevailing interest rates that leads an issuer of a callable bond to call that bond. In this case, call refers to the early redemption of a bond by the bond’s issuer. This can only be done if the bond issue includes a call provision in the offering, and this provision often includes a callable date. A bond with a callable date is not eligible for a call prior to that date. To make these bonds attractive to potential investors, callable bonds are typically offered with a higher coupon rate and a call price above par value.

Fluctuations in interest rates have implications across the economy. Many investments are subject to interest rate risk, also known as market risk, which is the risk that an investment loses value due to the relative attractiveness of prevailing rates. A bond with a fixed coupon rate is one example of an investment subject to interest rate risk. The rate trigger realizes that risk. In the case of a callable bond, a second danger is reinvestment risk, or the risk that investment options available to the investor after the bond is called are not as attractive as the original bond.

A Rate Trigger Turns Market Risk into Lost Interest Income

On January 1 of 2018, Company ABC offers 10-year callable bonds with an 8% coupon rate callable at 120% of par and a callable date of January 1, 2022. Interest rates rise and fall between the issue date and the callable date but remain close to 8% for one year after the callable date. On the first day of 2023, interest rates dip to 5%. This drop is a rate trigger. Company ABC closes a deal to offer new debt at 5% and will use the proceeds from this offering to repay its 8% bondholders. Company ABC exercises the option to call away the 8% bonds, so the investor receives $1,200 per $1,000 bond. The bondholder loses, however, the $400 in interest that would have been paid over the remaining life of the bond.

This example demonstrates the risk and rewards of a callable security in the event of a rate trigger. Prior to the company calling its bonds, the investor enjoys an above-market interest rate. The 2023 rate trigger realizes the market risk of a callable bond which results in lost interest income.

Published at Wed, 25 Apr 2018 22:52:00 +0000

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U.S. Treasury to close ‘carried interest’ loophole in new tax law

U.S. Treasury to close ‘carried interest’ loophole in new tax law

WASHINGTON (Reuters) – The U.S. Treasury said on Thursday it will close an unintended loophole created by the Republican tax overhaul that let some Wall Street financial managers dodge new limits on“carried interest” by operating as businesses known as S-corporations.

Carried interest refers to a longstanding Wall Street tax break that let many private equity and hedge fund financiers pay the lower capital gains tax rate on much of their income, instead of the higher income tax rate paid by wage-earners.

President Donald Trump vowed to close the loophole during the 2016 presidential election campaign.

Republican tax legislation signed into law by Trump in December required fund managers to hold investments for at least three years before becoming eligible for the lower capital gains rate, but it exempted corporations.

Media reports soon followed saying that some investment funds were setting up pass-through entities known as S-corporations in the hopes of qualifying for the corporate exemption and skirting the carried interest restriction.

On Thursday, the Treasury and its tax-collecting Internal Revenue Service announced that forthcoming regulations will prevent S-corporations from taking advantage of the carried interest exemption.

S-corporations are a form of business entity that passes profits on to business owners as personal income.

New Treasury rules are expected to specify that the exemption applies only to C-corporations, including publicly traded companies, which pay income tax before distributing net profits to shareholders as dividends.

“We worked expeditiously to take this first step to clarify that S corporations are subject to the three-year holding period for carried interest,” Treasury Secretary Steven Mnuchin said in a statement.

The American Investment Council, which represents private equity investors, welcomed Treasury’s guidance, saying in a statement that the government’s position“correctly clarifies the intent of the law.”

Reporting by David Morgan; Editing by Kevin Drawbaugh

Published at Thu, 01 Mar 2018 17:45:13 +0000

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Bets on U.S. inflation heat up in bond market

Bets on U.S. inflation heat up in bond market

NEW YORK (Reuters) – More investors are favoring U.S. bonds that profit from a pickup in inflation as the global economy gathers momentum with oil and other basic commodity prices recently hitting multi-year highs.

As a result, market forces in key economies and efforts by their policymakers might finally be aligning to lift inflation to 2 percent, a level the Federal Reserve and its counterparts in the euro zone and Japan desire but have failed to see for years, analysts and investors said.

If U.S. inflation hits that elusive level, Treasury Inflation Protected Securities could score solid gains in 2018, producing higher returns than regular U.S. government bonds.

“There’s global synchronized economic growth. Inflation is heading upward,” said Com Crocker, senior inflation analyst at New Century Advisors based in Chevy Chase, Maryland.

That upbeat view spurred $465.50 million of cash into funds that focus on TIPS in the week ended Jan. 3, bringing their total assets to an all-time peak of $67.39 billion, according to Lipper, a Thomson Reuters mutual fund research unit.

Last week’s net inflows into TIPS mutual and exchange-traded funds were the most in 10 months.

In the United States, inflation could be on the cusp of breaking higher, with passage of the biggest overhaul of the U.S. tax code in 30 years in December supporting bets of at least a near-term boost to business investment and hiring.

Adding to that are expectations of further weakness in the dollar, just off its worst annual performance since 2003, which would make foreign-made goods more expensive in the United States.

Meanwhile in the euro zone, signs of regional inflation gathering momentum has stoked speculation the European Central Bank might not renew its stimulative 2.55 trillion euro bond purchase program when it expires in September.

And in Japan the central bank scaled back its bond purchases on Tuesday on signs of improving domestic growth, sparking a global bond market selloff on fears the Bank of Japan may pare back stimulus later this year.

These factors augur the case to owning TIPS, but the lack of U.S. wage acceleration despite the lowest jobless rate in 17 years has curbed a wholehearted embrace of the $1.3 trillion sector.

“There’s no pressure from wages,” said Fred Marki, portfolio manager at Western Asset Management Co. in Pasadena, California. “It’s not enough to create excess demand with rising inflation.”


Another reason against loading up on TIPS is the global selloff in bonds so far in 2018, which intensified on Wednesday following a Bloomberg report that China might slow or stop its purchases of U.S. Treasuries in a review of its foreign exchange holdings.

China is the biggest foreign holder of U.S. government debt, with holdings totaling $1.19 trillion as of October.

Still some investors are betting on more gains in TIPS as the yield gap between 10-year TIPS and regular 10-year Treasuries broke 2 percent last week for first time since March. It reached 2.05 percent on Wednesday.

This measure of investors’ inflation expectations in the next decade has risen steadily from 1.66 percent last June amid surges in the price of oil and other commodities.

On Wednesday, U.S. crude futures reached a three-year peak above $63 a barrel on tightening supply, while zinc hit a decade-plus high on Tuesday


While more investors see TIPS as an inflation hedge, with an improving economic backdrop some analysts see stocks, corporate bonds and other riskier investments producing higher returns than TIPS.

“We are thinking of adding a bit of TIPS. It’s not a bad place for fixed income investors, but a better place to beat inflation would be equities,” said Andrew Richman, director of fixed income with SunTrust Advisory Services in Jupiter, Florida.

In 2017, TIPS produced a 3.0 percent total return, a tad better than 2.3 percent for standard Treasuries. Both trailed Wall Street’s record run with the S&P 500 racking up a 19.4 percent increase, the strongest since 2013.

Much of TIPS’ gains stemmed from rising inflation expectations. TIPS yields or “real” yields, have held in a tight range since late September.

The 10-year TIPS yield was last at 0.55 percent on Wednesday, up over 3 basis points on the day.


Since 2012, U.S. inflation has tended to pick up at the start of the year only to fade due primarily to a seasonal decline in oil prices.

The year-over-year increase on the Fed’s preferred inflation gauge, the core rate of personal consumption expenditure, has not topped 2 percent since February 2012. It was running at 1.5 percent in November.

The Consumer Price Index, which measures a broader basket of goods and services, ran at 2.2 percent on a year-over-year basis in November.

TIPS principal and interest payments are adjusted against the CPI.

The Labor Department will release its December CPI report at 8:30 a.m. (1330 GMT) on Friday. Analysts polled by Reuters forecast the CPI likely rose 0.2 percent in December for a year-over-year increase of 2.1 percent.

Even if CPI grows modestly, it would be enough to entice investors.

“TIPS look attractive as a form of insurance,” Western Asset’s Marki said. “The demand for TIPS will remain.”

Reporting by Richard Leong; Editing by Daniel Bases and Chizu Nomiyama

Published at Wed, 10 Jan 2018 18:18:57 +0000

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