Why The Treasury Curve Has Been Flattening Like A Pancake: Pension Fund Buying And Tax Reform

govttrader's picture

TL/DR: Tax reform creates pension fund incentive to buy 30yr bonds NOW.

Currently, the top corp tax rate in the US is 35%. It looks most likely that rate will drop to 20% when tax reform passes. If you are a corp with an underfunded pension fund, you get a tax incentive to fund the pension THIS YEAR vs in the future when the corp tax rate drops to 20%. Why? Because contributions to the pension plan are tax deductible. You get a bigger tax deduction in 2017 then you will get in 2018 and onwards (assuming tax reform happens in something close to its current form...which it looks like it will).

Multiple primary dealers have reported pension buying in the 30yr sector over the past month, and coincidentally, 30yr bonds have rallied while the front end has sold off for the past month. Pension funds have a favorite bond to buy...STRIPS (30yr zero coupon bonds - higher yield than normal coupon bonds, better asset/liability match..more price sensitive to changes in yield...bigger bang for your buck in a bond rally..and is a flattener to the yield curve). Pension funds don't trade very much....they tend to buy and hold.

So these flows will SIGNIFICANTLY flatten the 30yr curve...and that is exactly what we have been seeing.

1 Month of US Yield Curve Changes

US Treasury yield changes (basis points) since Oct 24, 2017

So, step 1, Mystery Solved.

But Wait, There's More.  If corp pensions are buying 30yr bonds, they are also buying stocks, to keep their relative portfolio weights stable (explains the recent stock rally). 

However, come Jan 1 2018, that buying will evaporate, and then DOWN GOES FRAIZER (Fraizer is the US stock market).

 

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RichardParker's picture

Back in '82 Merrill was offering STRIPS earning about 12.5% interest.  Face value of $1000 was going for about 35 bucks, maturing in 2006.

http://www.nytimes.com/1982/08/10/business/merrill-offers-new-zero-issue...

Those were the days...

NumbersUsa's picture

Oy vey! Now, seven flags over Texas? by hedgeless_horseman Nov 20, 2017 12:30 PM

IT"S GONE

Isn't it amazing how much power the jew supremacists have to make articles exposing their takeover of America disappear and replace them with articles featuring giant dildos for goy amusment.

Ripped out of ZH's lineup : http://www.zerohedge.com/news/2017-11-20/oy-vey-now-seven-flags-over-tex...

you can't even find it in a ZH search.

Call your Congressman, Senator & the WhiteHouse and let them know we want the zionist neo-con dual citizen jews out of all areas of our government NOW! 

For the President-White House switchboard at 202-456-1414

White House comment line: (202) 456-1111

To call your Member of Congress: 
US Capitol Switchboard (202) 224-3121 (just ask for your Congressman or Senator)

Imagery's picture

And how exactly are they making Pension distributions to the boomers now retiring at 12k per day plus if they are only buying Zero Coupon Bawnds?

konadog's picture

When a zero matures, the bond holder gets $1000 per bond in cash. Ladder the zero maturities and voila. Seriously, not that complicated.

Peacefulwarrior's picture

What happens if the long end of the curve continues to flatten?

govttrader's picture

These asset purchases are not really for the benefit of the pensioners...they are just to reduce 2017 tax liability.

Iconoclast421's picture

You know there is nothing stopping the Fed from buying STRIPS. Can you imagine the kind of leverage they can impart onto the bond market?

wcvarones's picture

This would suggest there's also a lot of equity buying by the same pensions, and it will dry up January 1.

konadog's picture

Don't worry, the Bank of Japan and the Swiss Central Bank will make up the gap.

totenkopf88's picture

I didn't know that it was possible to not know the Fed will buy equities any time the market dips 2%. 

SurlysonofaBitch's picture

Interesting, but why are the (reported, non-GAAP) earnings so strong if companies are accellerating expenses to lower taxable income for 2017?

wcvarones's picture

Pension costs are accounted for by accrual, not cash payments, right? So pre-funding wouldn't hit earnings.

herkomilchen's picture

AFAICT you are exactly right and this article's argument doesn't hold up.

This year's cash contribution by the company or bond buying by its pension fund has no impact whatsoever on this year's deductible pension expense.  Pension expense is set by accrual accounting, smoothed, and fixed a year in advance.

govttrader's picture

This activity is just starting to gear up over the last 1-2 months.  I suspect we will see it reported at the end of the current quarter.