While U.S. insurance companies have adapted to investing in a world of low interest rates, they are now also facing the challenge of investing in a high inflationary environment whereby yields may not be providing adequate returns on investment on an inflation-adjusted basis. Using a similar approach to estimating real interest rates in Chart 1, we estimate how corporate bond yields are holding up against high inflation
Graph 3 shows similar data for BBB-rated corporate bonds. With BBB yields generally higher than A yields, the difference between the two measures has been negative for a shorter period of time. Real yields did not turn negative until May 2021, and they dipped to almost -1% in December 2021.
Author(s): Michele Wong and Jennifer Johnson
Publication Date: 15 Feb 2022
Publication Site: NAIC Capital Markets Bureau Hot Spot
Of the $8.3 trillion of liquid marketable securities in the Fed’s portfolio (see the chart below), 37 percent are overnight repos and Treasury securities maturing in one year or less, 26 percent are T-notes maturing in one to five years, and another 30 percent are mortgage-backed securities issued by Fannie Mae and Freddie Mac, which pay down principal and interest monthly. So all it takes to pull back the excessive monetary stimulus left over from the COVID-relief era is to let such holdings roll off in 2022-24 without replacing them with new purchases. Operationally, it’s really not rocket science — it’s just a matter of conviction and messaging. Unlike the rising stairstep expected in the Fed’s overnight rates, its bond portfolio runoff won’t make nightly news headlines; it’s like watching paint dry. In this regard, doing nothing is actually doing something quite constructive on the inflation front, despite the lack of fanfare.
What would be the impact on interest rates? Little doubt they must go higher, barring an exogenous shock like a global virus lockdown or a Ukraine-war flight-to-safety. The key question is really how much higher, and how fast. My best guess is that markets have recently discounted about one-third of the potential move higher in long-term rates.
Central bankers in developing countries have been ratcheting up interest rates for months, seeking to stay ahead of a rise in U.S. rates that could destabilize their economies by pushing up their own cost of debt, weakening their currencies and driving capital out of their markets and into higher-yielding U.S. securities.
Now, the Fed is expected to raise rates anywhere from four to seven times this year. If successful in taming inflation, the Fed could help central banks everywhere, because a turbocharged U.S. economy, huge government stimulus and a splurge by Americans on everything from toys and household appliances have snarled supply chains and driven inflation higher world-wide.
Until now, overseas central banks have found it difficult to get on top of the inflation surge withthe Fed sitting on the sidelines. But with the Fed now poised to join the battle, some say the prospects of success are greater.
The combined total of the required Fiscal Year 2023 State contribution for the six retirement systems was $10.97 billion, an increase of $0.14 billion over the previous year. Cheiron verified the arithmetic calculations made by the systems’ actuaries to develop the required State contribution and reviewed the assumptions on which it was based.
The Illinois Pension Code (for TRS, SURS, SERS, JRS, and GARS) establishes a method that does not adequately fund the systems, back loading contributions and targeting the accumulation of assets equal to 90% of the actuarial liability in the year 2045. This contribution level does not conform to generally accepted actuarial principles and practices. Generally accepted actuarial funding methods target the accumulation of assets equal to 100% of the actuarial liability, not 90%.
According to the systems’ 2021 actuarial valuation reports, the funded ratio of the retirement systems ranged from 47.5% (CTPF) to 19.3% (GARS), based on the actuarial value of assets as a ratio to the actuarial liability. If there is a significant market downturn, the unfunded actuarial liability and the required State contribution rate could both increase significantly, putting the sustainability of the systems further into question.
Author(s): Frank J. Mautino
Publication Date: 22 Dec 2021
Publication Site: Office of the Auditor General, State of Illinois
The average interest rate paid by Washington on its debt has fallen from 8.4 percent to 1.5 percent over the past three decades. However, economic variables tend to fluctuate, and only a fool would assume that a current economic trend will last forever. In the past, economic forecasts and markets told us that high inflation and high unemployment cannot happen simultaneously, that the late-1990s tech-stock bubble wouldn’t burst, and that national housing prices can never fall. Just last year, the Federal Open Market Committee consistently underestimated current-year inflation by three full percentage points. Interest-rate forecasts have proven spectacularly wrong for 50 years.
But now, economic commentators assure us that soaring federal debt is affordable because interest rates will remain low forever.
By contrast, the Congressional Budget Office projects that rates will nudge up to 4.6 percent over three decades. That is easily possible. After all, a broad range of studies show that the projected 100 percent of GDP increase in federal debt over the next three decades should, by itself, add three percentage points to interest rates. Added federal debt over the past 15 years also put upward pressure on interest rates, but this was offset by low productivity, baby-boomer savings, and Federal Reserve policies that pushed rates downward. For interest rates to remain low, those offsetting factors would have to accelerate much further to counteract the three-percentage point effect of future debt.
According to the U.S. Treasury, in fiscal 2021, the amount of interest paid on the national debt was $562 billion including government transfers. The amount actually paid out to holders of U.S. securities was $413 billion.
That figure alone, which is over 20% of what we paid in income taxes in FY 2021, should be alarming when compared to other government expenditures.
Compare the $413 billion we pay in interest to holders of these securities to the annual budgets of other parts of the government. The State Department annual budget is “only” $35 billion and the Justice Department $39 billion.
Interest rates are still near an all-time low. According to the Monthly Treasury Statement, in 2001, interest paid on the national debt was an average of 5.4%, about 3½ times what it is now.
If we get back to that rate, which is far from inconceivable, interest on the debt would cost American taxpayers $1.4 trillion, based on our present level of national debt. That is twice the budget of the Defense Department.
Even with exceptionally low interest rates, the federal government is projected to spend just over $300 billion on net interest payments in fiscal year 2021. This amount is more than it will spend on food stamps and Social Security Disability Insurance combined. It is nearly twice what the federal government will spend on transportation infrastructure, over four times as much as it will spend on K-12 education, almost four times what it will spend on housing, and over eight times what it will spend on science, space, and technology.
Publication Date: 10 Mar 2021
Publication Site: Committee for a Responsible Federal Budget
Today’s graphic from Paul Schmelzing, visiting scholar at the Bank of England (BOE), shows how global real interest rates have experienced an average annual decline of -0.0196% (-1.96 basis points) throughout the past eight centuries.
The Evidence on Falling Rates
Collecting data from across 78% of total advanced economy GDP over the time frame, Schmelzing shows that real rates* have witnessed a negative historical slope spanning back to the 1300s.
Displayed across the graph is a series of personal nominal loans made to sovereign establishments, along with their nominal loan rates. Some from the 14th century, for example, had nominal rates of 35%. By contrast, key nominal loan rates had fallen to 6% by the mid 1800s.
In May of 2020, Hoenig published a paper that spelled out his grim verdict on the age of easy money, from 2010 until now. He compared two periods of economic growth: The period between 1992 and 2000 and the one between 2010 and 2018. These periods were comparable because they were both long periods of economic stability after a recession, he argued. The biggest difference was the Federal Reserve’s extraordinary experiments in money printing during the latter period, during which time productivity, earnings and growth were weak. During the 1990s, labor productivity increased at an annual average rate of 2.3 percent, about twice as much as during the age of easy money. Real median weekly earnings for wage and salary employees rose by 0.7 percent on average annually during the 1990s, compared to only 0.26 percent during the 2010s. Average real gross domestic product growth — a measure of the overall economy — rose an average of 3.8 percent annually during the 1990s, but by only 2.3 percent during the recent decade.
The only part of the economy that seemed to benefit under quantitative easing and zero-percent interest rates was the market for assets. The stock market more than doubled in value during the 2010s. Even after the crash of 2020, the markets continued their stellar growth and returns. Corporate debt was another super-hot market, stoked by the Fed, rising from about $6 trillion in 2010 to a record $10 trillion at the end of 2019.