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ion plan have invested in long term infrastructure projects at home and abroad as a means of boosting returns such opportunities are far and few between in the us many pension plans have invested in hedge funds and a variety of financial derivatives as a way to overcome low yields from traditional assets nonetheless this search for yield does not move the needle sufficiently to allow the pension funds to meet their targets by no means is this situation confined to the us the british pension industry has been underfunded for sometime and the situation became a whole lot worse following the brexit vote uk interest rates fell significantly since the june vote applying more pressure on managers to correct underfunding finally the wave of negative interest rates in germany and other eu countries have made pension managers lives a lot more difficult in their search for positive returning assets what does the future have in store for pension funds the oecd study does not mince words it states to reduce insolvency risks insurers may need to offer lower guaranteed returns on new contracts to reduce liabilities and in extreme cases renegotiate current terms pension plan sponsors could adjust or terminate existing plans and offer less attractive terms to new employees defined benefit pension plan sponsors could increase contributions to funds regulators and policy makers will need to remain vigilant to prevent excessive search for yield 1 implicit in this report is the recognition that slow global income growth and low interest rates will dominate the international community and historic investment targets are not expected to be repeated thus we can anticipate a number of changes in the industry including the demise of the defined benefit program younger members having to pony up more in pension contributions taxpayers topping up state plans a continual re assessment of longevity risks and an downward adjustment to overall investment targets these changes amount to a significant adjustment to the parameters that guide pension funds going forward 1 oecd pension market in focus 2015 _________________________________________________________________________ sign up for our daily newsletter called the daily shot it s a quick graphical summary of topics covered here and on twitter see overview emails are never sold or otherwise shared with anyone _________________________________________________________________________ soberlook com saturday july 16 2016 the looming shortage in government bonds guest post by norman mogil ever since the 2008 financial crisis there has been a persistent shortage of high quality government debt more than just a safe haven in times of financial stress the so called flight to quality the supply of high quality sovereign debt has been steadily shrinking this shortage became acutely apparent with the results of the brexit referendum as investors worldwide bid up bond prices to the point where most long term bond yields reached historic lows in the us uk germany and japan brexit only exacerbated a shortage problem that bond investors have had to contend with for nearly a decade the current squeeze in supply is just the latest manifestation of this wider issue in today s financial markets to claim that there is a shortage of government debt must seem counter intuitive to many readers after all there is no end of studies demonstrating that major economies have record high government debt to gdp ratios signifying that there is too much debt not too little many critics call for governments everywhere to issue less debt arguing that such high levels of debt ratios contribute to sluggish growth if not outright stagnation european governments continue to exercise spending restraints and in general austerity is the byword throughout the industrialized world governments have been very reluctant to open up their coffers by issuing more debt to fund expenditures however a case can be made for more government debt in a recent article the world needs more u s government debt former fomc member narayana kocherlakota argued this case succinctly when he wrote but scarcity is not about supply alone in the wake of the financial crisis households and businesses are demanding more safe assets to protect themselves against sudden downturns similarly regulators are requiring banks to hold more safe assets market prices tell us that the government needs to produce more safety in order to meet this increased demand the inadequate provision of safe assets also has profound implications for financial stability without enough treasury bonds to go around investors reach for yield by buying apparently safe securities from the private sector if such behavior becomes widespread it can create systemic risks that tip the financial system into crisis to better understand how bonds became scarcer we begin by looking at who is buying government debt and why the expanding role of central banks as the federal reserve sought ways to stimulate the economy it became the first major central bank to start a bond purchase program quantitative easing qe soon after the bank of england boe the bank of japan boj and most recently the european central bank ecb developed their own versions of qe chart 1 the us fed holds nearly 20 percent of all federal government debt the boj owns over 30 percent the boe 25 percent and the ecb has so far bought about 15 percent of german debt the fed is no longer purchasing debt while the other central banks continue with their qe programs the fed increased its balance sheet dramatically from about 800 billion to over 2 4 trillion under three qe programs although the fed no longer actively purchases government bonds it appears in no hurry to release those bonds into the marketplace instead allowing the bonds to mature fully over time over 40 percent of outstanding us treasuries are held by foreign central banks sovereign wealth funds and other institutions china and japan together account for about 12 percent as the us runs current account deficits with its major trading partners the excess in us dollars are re cycled into purchases of us treasuries more importantly many central banks especially those in emerging countries have purchased treasuries in increasing amounts and holding them to shore up their balance sheets and to provide needed foreign exchange reserves in sum treasuries are been soaked up by us domestic and foreign entities as part of a worldwide push to strengthen balances in the private and public sectors in the wake of the 2008 financial crisis the ecb and the boj both continue with very aggressive bond purchasing programs the boe may be forced to expand its current program in response to the fallout from uk voters opting to leave the eu the ecb came late to the game of bond purchases starting in 2015 some six years after the us first implemented qe initially the ecb embarked on a program of purchasing government debt at a rate of 50 billion euros per month but as the supply of qualified government debt diminished the ecb increased its bond purchasing program to included corporates overall the ecb program now soaks up about 80 billion euros a month of high quality debt speculation is ripe that the ecb will do more bond purchasing in the wake of the brexit vote turning to japan the boj has long been a huge purchaser of domestic government bonds jgbs over the next four years the boj is expected to own over 60 percent of all outstanding jgbs the highest of any country growing domestic needs for treasuries domestically major holders of treasuries include federal government and state local pension plans table 1 these plans will require additional risk free treasuries to meet longer term obligations us charted banks have significantly increased their holdings of treasuries and agency debt as a means of strengthening their balance sheets from 2013 to the present commercial banks increased holdings of treasuries by 30 percent finally private pension funds and the life insurance companies hold approximately 6 percent of their assets in treasuries industry analysts argue that proportion is inadequate to meet future liabilities and it is expected that these institutions need to double their holdings to satisfy future income requirements in short government bonds will be a strong asset class from here on out as these institutions re balance their portfolios to meet long run requirements the phenomenon of negative interest rates one does not have to look any further than the exploding market for negative interest rate bonds to find convincing proof of a bond shortage today negative interest rate bonds total over us12 trillion in europe and japan chart 2 more importantly the average duration of these bonds has increased remarkably just within the past year negative yields extend out to 10 years in germany 15 years in japan and even as far as 30 years in switzerland http soberlook com 2016 04 understanding negative interest rates html not surprisingly central banks themselves are having trouble finding all the bonds they need for example the ecb is not permitted to buy bonds with a yield lower than its deposit rate of minus 0 4 percent thus excluding many billions of euro dominated bonds issued by switzerland germany france netherlands and sweden in other words there is a real squeeze on positive yielding safe haven bonds vanishing credit quality and liquidity since the emergence of the debt crisis in europe starting in 2012 there has been a wave of national debt downgrades the bank of america merrill lynch estimates that the share of bonds with the three highest credit ratings has dropped to 51percent of all debt tracked by the bank s world sovereign bond index from 84 percent in 2011 with so many institutions restricted from purchasing anything less than high quality bonds managers are facing a smaller and smaller market in which to participate credit worthiness comes into play in the very large repo loan market where high quality debt is used as short term collateral by hedge funds money markets private equity and other lending groups it is estimated that the volume of repo loans using treasury debt has nearly halved since the financial crisis of 2008 on the issue of liquidity there have been system wide reductions even in the case of the us treasury market considered to the most liquid of all bond markets regulatory changes post 2008 have made bond dealers less willing to hold inventory and facilitate trades bond trading desks have slashed inventories in response to regulations such as basel iii and the volcker rule hence primary dealers have reduced their u s debt holdings by as much as 80 percent according to bloomberg com estimates these liquidity developments have prompted barry eichengreen of uc berkeley to argue that international liquidity has plummeted from nearly 60 percent of global gdp in 2009 to barely 30 percent today recent auctions for us treasuries feature large oversubscriptions and this has driven yields lower there is more than just a temporary flight to safety to quality debt there appears to be a major shift in asset preference in favour of high quality debt issued by the us and other major countries at a time when the supply of that debt is not keeping with demand outlook for supply in a recent report bank of america merrill lynch said that the world is running out of positive yielding safe haven bonds the looming shortage has implications in many segments of the fixed income market every indication points to a worsening of the supply shortage of high quality bonds in the us the 2016 federal deficit is expected to be lower than the previous year by some 25 percent to finance this lower deficit the treasury has opted to issue more bills instead of bonds as a means of lowering interest costs this combination will exacerbate the shortage situation and will most likely keep long rates down at these current levels in europe the ecb is running out of qualified government bonds to purchase in the wake of a growing segment of the market having gone deep into negative territory it has had to resort to buying corporate bonds to satisfy its purchasing objectives there is no sign that euroland will ease up on its austerity program and we can expect a tight supply of new government issuance in 2016 17 japan continues to wallow in deflation and the boj is continues to be under pressure to step up its bond purchasing program driving longer dated yields ever lower from a supply perspective alone we can expect that long term rates will be kept at these historic low levels _________________________________________________________________________ sign up for our daily newsletter called the daily shot it s a quick graphical summary of topics covered here and on twitter see overview emails are never sold or otherwise shared with anyone _________________________________________________________________________ soberlook com sunday june 19 2016 what the bond market is telling investors guest post by norman mogil over the past month the global bond markets have been sending out signals that all is not well with the global economies initially the surge in negative nominal rates in europe and japan rattled many investors in both the fixed income and equities markets this historic development suggests that large scale investors are anticipating low growth and disinflation for many more years simultaneously the yield curve especially in the us has been flattening again signalling that growth is slowing giving the policy makers considerable pause in their deliberations on the course of future interest rates this blog examines both these developments to help the reader understand the signals coming out of the bond markets around the world nominal and real rates of interest for more than a year short to medium term rates of interest in many countries have landed in negative territory the ecb instituted negative overnight lending rates in an effort to discourage commercial banks from depositing excess reserves with the ecb instead these such funds should be made available to their borrowers in the hope of stimulating loan demand throughout the region more recently the ecb started to buy initially longer dated sovereign debt from member countries in the expectation that long term rates would fall to stimulate investment growth now the ecb has expanded this quantitative easing program to include investment grade corporate bonds purchases of both types of debt exceed 80 billion euros a month as the ecb pulls out all stops in pursuing its goal of re inflating the eu economies the result of this combined effort is shown in table 1 which reveals that major european countries and japan now live under a regime of negative long term rates of more significance is the measure of real rates of interest nominal rates minus the rate of inflation in some countries real rates have turned negative e g japan switzerland and canada and in ot...