Goldman: Beefing Up Corporate Pensions Will Flatten the Yield Curve

The firm says companies will be heavy bond buyers, contributing $60 billion to their pensions due to a tax change.

The new tax reform package is pushing S&P 500 companies to inject billions into their underfunded defined-benefit pension plans, a move that Goldman Sachs says is leading to large bond purchases that will help flatten the yield curve.

Under the revamped tax code, companies have until mid-September to plug in the contributions to their DB pension plans and, because these are business expenses, get a deduction under the old corporate tax rate of 35%. After the deadline, they get a lower deduction, based on the new tax rate of 21%.

Goldman expects about $60 billion in contributions from plan sponsors this year. FedEx, PepsiCo, Verizon, Deere, and Alcoa have already made large public donations totaling $5.4 billion. As the window to grab deductions closes, the firm expects additional sponsors to make contributions. 

Last year, the S&P 500 companies contributed $63 billion to corporate pension plans, the highest since 2003. (Their motive for making the extra contributions: Once their plans are fully funded, many are expected to transfer the assets to insurers to get the pension obligation off their books.)

When adding money to a DB pension plan, companies typically prefer moving into long-duration bonds, as fixed-income is less risky than stock. This, in turn, creates a higher demand for long-term bonds, particularly 10- and 30-year Treasury issues.

In Goldman’s view, such massive purchases will help further compress the yield curve, which already is almost flat, with just 0.28 percentage point between the yields of the two- and 10-year Treasury bonds. Buying so many long-term bonds boosts their prices, and this action depresses their yields.

Goldman is projecting US corporate pensions will buy $150 billion in long-duration bonds annually for the next several years.

“Our work would indicate that the aggregate GAAP funded status of the US corporate DB system has risen from 81%, as of the end of 2016, to an estimated 89%, as of June 201,” Goldman said in a new pension solutions report. As a result of this increase in funded levels, some plan sponsors have hit triggers on their glide paths and enacted shifts in asset allocation toward more fixed income as a means to better hedge their liabilities.”

The yield for the 10-year Treasury note benchmark is down 18 basis points from the May 17 high of 3.11%, to 2.95%, according to Reuters. The 30-year bond yield is down 19 basis points, to 3.08%.

Corporate pensions have not only been de-risking with bonds, but also in alternatives such as defensive equity, low-volatility strategies, or hedge funds. However, a large chunk of their risks is still dominated by equities.

“Many glide path strategies may still have around 10%-20% of the portfolio allocated to return-seeking assets even when they reach their end state point,” Goldman said. “We expect more plans to take a closer look at the makeup of their return-generating portfolio as they move along their glide path, especially as we get into the late innings of the current economic expansion.”

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