Wall Street Warns of Seismic Pension Shift Into Bonds This Month

Updated on
  • Billions of dollars seen flowing to Treasuries as stocks rally
  • Pensions’ bond purchases support yield curve flattening: JPM
Bridgewater Associates Founder Ray Dalio says bonds are in a bear market.

The bond bear market, touted by billionaire fund managers Bill Gross and Ray Dalio, is about to run into a multi billion-dollar roadblock.

Strategists across Wall Street, from Credit Suisse Group AG to JPMorgan Chase & Co., predict that the run-up in stocks will spur portfolio rebalancing by U.S. pension funds, driving pent-up demand into bonds as managers shift their more than $7 trillion in assets. While the S&P 500 Index has returned about 6.2 percent since the beginning of the year, 10-year Treasury futures have slumped 1.5 percent, pushing yields to near the highest since 2014. The bond benchmark was little changed in trading Thursday.

With those profits and losses in mind heading into month-end, pensions will purchase about $24 billion in fixed-income securities, while selling an unusually high $12 billion of U.S. equities, according to a Credit Suisse model. And they don’t have many more chances to make the shift: funds have less than five trading sessions to complete their month-end allocation requirements. On top of that, the Federal Reserve’s policy meeting falls on Jan. 31, which may push some to get their trades done early.

All told: don’t be surprised if the Treasuries selloff pauses for a deep breath.

“One of the biggest forces supporting fixed income are the rebalancing flows emanating from multi-asset investors who are trying to prevent the equity weightings of their portfolios from rising too much,” JPMorgan strategists led by Nikolaos Panigirtzoglou wrote in a report. There’s “more significant rebalancing required from this year’s rapid gains in equity markets.”

By JPMorgan’s calculations, each 1 percent climb in stocks equates to $25 billion of bond buying by U.S. pensions to keep their asset allocation balanced. State and local government defined-benefit plans have about 60 percent in equities and 25 percent in fixed income, while for private plans, the split is closer to 50-40. In total, that’s $125 billion of rebalancing in the wings.

The vast majority of pension purchases will probably be longer-dated Treasuries, supporting the trend of yield-curve flattening. The spread between 5- and 30-year securities remains close to the narrowest since 2007. The Fed’s three interest-rate hikes last year boosted yields in the short end, but have done little to rattle the longest maturities.

That’s in no small part because of the demand from pensions. Yields of 2.92 percent on 30-year Treasury bonds are enough for the average European pension fund to start de-risking, and building up its stake in bonds. Many U.S. state and local pensions have loftier return requirements.

Despite the prognostications for higher yields, Treasuries aren’t about to lose their appeal for captive buyers. On top of pension demand, funds tracking the Bloomberg Barclays US Treasury index need to buy more too, with the benchmark’s Treasury duration increasing at month-end by 0.08 years, compared with the average 0.06 years over the past decade.

Even with anxiety about rising debt supply in 2018, as long as the stock market keeps up its bull run, there should be increased pension demand to match it.

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