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Markets are fixated on the tit-for-tat trade war between China and the United States. But the U.S. bond market might start grabbing new attention.
The yield on the 10-year U.S. Treasury note is back up at 3.23 percent, hitting fresh multi-year highs. Bond yields – the amount they pay out to investors who hold them – move inversely to prices. So when bond prices decline, as they have recently, their yields edge higher.
As recently as last month, technical strategists were pointing out that a firm break of the 10-year yield through 3.05 percent could set yields on a higher trajectory in the long term. But there's reason to believe that may stall, even with the U.S. Federal Reserve widely expected to raise rates.
Pension funds, especially in the United States, may be poised to swoop into the bond market — especially in a world where one quarter of all interest rates are negative.
"The bond market could see a bid emerge from the private pension fund community, that currently stands around $3 trillion universally in assets under management," according to a September note from J.P. Morgan Research analyst Nikolaos Panigirtzoglou.
Pension funds' "funded status" – the percentage of funds' assets over their liabilities – has improved substantially over the course of 2018. Pension funds generally hold portfolios of both stocks and bonds. This year, the stocks held by many pension funds have gained value along with the wider market.
U.S. pension funds are better funded now than they have been in a long time, said Panigirtzoglou, who cited numbers from analytics firm Milliman. The 100 biggest "defined benefit" pension schemes — those that use a predetermined formula to determine what they pay out —have a funding deficit of less than $100 billion currently. That's down from around $400 billion in 2016 and the lowest the deficit has been in a decade.
Meanwhile, private pension plan sponsors in the United States are making greater contributions to their pension savings in anticipation of lower corporate tax rates.
According to a September 17 note from Goldman Sachs research analyst Avisha Thakkar, longer-duration bonds have seen prices find a bottom because companies were recently increasing their defined benefit contributions, by way of longer-dated bond purchases. They did so ahead of the September 15 corporate tax deadline, which gave them the benefit of higher tax deductions using 2017 corporate tax rates.
The team at Goldman Sachs concluded that "benefit plans are likely to rotate more heavily into fixed income on better ratios and as the Fed continues to raise rates," thereby raising the attractiveness of risk-free instruments.
Of course, not everyone agrees that bond-buying from pension funds will put a cap on yields. A report released last week by the Commodity Futures Trading Commission showed an increase of net "short" positions by traders, indicating they believe that yields could continue to move higher.
Bonds comprise about 45 percent of the holdings of U.S. pension funds, according to J.P. Morgan, compared with about 60 percent in Europe and Japan. Hypothetically, if U.S. pension funds were to increase to European levels, that would imply about $450 billion moving into U.S bond markets.