The recently approved second round of quantitative easing could further deteriorate the funded status of U.S. corporate defined benefit pension plans if long-term interest rates are lowered, putting continued funding pressure on companies, according to Mercer.
In the near term, lower rates on Treasury debt will bring down yields on high-quality corporate bonds used to discount pension liabilities.
However, if the second round of easing, known as QE2 and approved by the Fed last week, jolts life into the U.S. economy, the move could benefit pension funds in the long term.
“Higher interest rates, resulting primarily from a moderately higher inflation rate, would decrease pension liabilities,” Jonathan Barry, partner in Mercer’s retirement, risk and finance group, said in a news release. “At the same time, in a positive scenario, the value of plan assets could increase if the equities market improves as a result of improved business conditions and profitability.”
I've already written on how quantitative easing is bringing pensions to the brink. And don't forget what Leo de Bever of AIMCo recently told me about the Fed's policy:
"Banks do not mark their commercial real estate to market. Quantitative easing (QE) is all about giving banks enough of a cushion to absorb these losses. For Bernanke, keeping the system afloat takes precedence over everything else. Not sure he's wrong but he's solving one crisis by sowing the seeds of another."
While QE2 stirs up passions, the truth is nobody really knows how this is going to end. It might turn out to be a disaster, or it might turn out to be a stroke of genius. For me it's simple, there is no choice but to keep reflating risk assets and introduce mild inflation in the economic system. There are risks to this policy but the reality is they're going to do whatever it takes to avoid a protracted debt deflation cycle.
Pensions need to see asset values and interest rates rise so that deficits start shrinking significantly. And even then, it won't be enough. That's why policymakers are raising the retirement age, lowering investment return assumptions, cutting benefits and increasing contribution rates to shore up pension plans.
I believe QE2 will ultimately help pension plans. The Fed is feeling the state's pension pain and is moving to quickly defuse the neutron bomb using any means necessary. That's why I keep telling people to buy the dips, risk assets will keep rising. No matter what you think, if you fight the Fed, you will lose.