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    US pension market quarterly

    US pension market quarterly

    A statistical and qualitative review of Q3 2021 and investment outlook

    Download the full report.

    We expect yields to remain lower for longer

    The Federal Open Markets Committee (FOMC) faces a tricky balancing act. Members clearly want to signal a more hawkish tone, and to reduce the excess liquidity that has flooded the system. However, with Treasury supply expected to remain elevated for years to come, any reduction in Treasury purchases will require markets to absorb a greater proportion of supply.

    At Insight, although we acknowledge the ‘taper talk’ and speculation of early interest rates rises, we believe there is unlikely to be any dramatic reversion to historical norms. The level of debt in most economies will make it extremely difficult for central banks to escape the era of low yields that they have created. 

    Summary

    • Elevated levels of inflation give the more hawkish members of the FOMC a greater voice for now, but we don’t believe this will last, with the eventual ‘lift-off’ likely to be slow

    • In pension news, we note some of the pension-related proposals within the Reconciliation bill, and highlight the Department of Labor’s FAQ on lifetime income rules
    • In credit, we look at the outlook for credit spreads and examine two historical scenarios: In 2004, spreads were low but trended sideways for a significant period, whereas in 2007 spreads widened dramatically from compressed level
    • In our market outlook, we highlight the potential peak in delta variant cases, and examine why we believe the market risks from a withdrawal of quantitative easing are small
    • Key risks include stickier than expected inflation, forcing a more disruptive response from the Fed, and pressure on corporates to increase leverage in the low environment, leading to credit downgrades and greater financial risk
    • In our educational section we highlight our latest Global Macro Research paper – Desynchronizing recoveries, where we assess the differentiated pace of economic recovery as the world emerges from pandemic induced recession
    Doves versus hawks – balancing the risks

    Three factors that could sway the policy tone in the months ahead:

    1. Elevated levels of inflation support the hawks for now

    With inflation breaching 5% and GDP returning to its pre-pandemic trend more quickly than expected, it is unsurprising that some members of the FOMC feel the need to take a hawkish tone.

    However, inflation has so far been dominated by ‘volatile’ rather than ‘sticky’ categories, underpinning our view that inflation will struggle to remain at such an elevated level.

    Some of the more volatile price items have already started to normalize, for example:

    • Used car prices declined by 1.5% month on month in August
    • Hotel prices declined by 3.3%
    • Owners' equivalent rent (over 20% of the inflation basket), has failed to gain any meaningful momentum

    Figure 1: The key drivers of the recent acceleration in inflation have already started to moderate

    2. Delta variant adds to the doves' argument but cases appear to be peaking

    The resurgence of cases in the form of the more contagious delta variant has strengthened the argument of the doves, as it exacerbates the downside risks to the recovery. Although the vaccine rollout has dramatically reduced the probability of renewed large-scale restrictions, the rises in cases has slowed the pace of economic growth in the third quarter, and negatively impacted consumer confidence. 

    3. There is no rush to tighten but longer yields could drift upwards

    We expect the Fed to announce its plan to ‘taper’ its asset purchases in November this year and to then implement this policy over 2022, with the first rate-hike to potentially follow in 2023.

    Although Fed policy should help to anchor longer Treasury yields, the recent rally has taken them towards the lower end of their recent trading range. This leaves us more cautious on a valuation basis, and we anticipate an upward bias to yields into the end of the year.

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    There is a difference between knowing the path and walking the path

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    There is a difference between knowing the path and walking the path

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    Morpheus, The Matrix (1999)
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