The Fed May Have Saved Pensions in 2013

Source: http://www.flickr.com/photos/68751915@N05/

Source: http://www.flickr.com/photos/68751915@N05/

Pension funds were in bad shape at the end of 2012. According to an estimate by JPMorgan obtained by the Wall Street Journal, corporate-sector pension funds in the United States were meeting, on average, only 77 percent of their liabilities last year. This too-low funding level was effectively unchanged from 2008 when the financial crisis wiped out more than 20 percent of the value of assets held by pensions. But as 2013 begins wrapping up, the outlook is very different. JPMorgan estimates that pension funds will be 96 percent funded by the end of the year.

The return to health can largely be attributed to the stock market rally. Major U.S. equity indices are trading at or near all time highs: as of December 11, the S&P 500 was up 21.87 percent year to date, the Dow Jones Industrial Average was up 18.12 percent, and the Nasdaq was up 28.65 percent.

This rally has helped heal the damage that pension funds suffered from the financial crisis. According to the Wall Street Journal, the JPMorgan report attributes 60 percent of the improvement in pension funding levels to equities, which currently account for about 52 percent of corporate pension plans.

Many investors and market watchers have attributed the post-crisis market rally to the U.S. Federal Reserve’s highly accomodative monetary policy — and, specifically, to quantitative easing. Quantitative easing, or QE, is a program through which the Fed is purchasing $85 billion worth of agency mortgage-backed securities and longer-term Treasury securities every month.

The Fed began the current round of asset purchases in September 2012. These purchases increase the price of those financial assets, which lowers their yield, putting additional downward pressure on long-term interest rates. The intended consequence is to spur spending in interest rate sensitive sectors, which, as Fed Vice Chair Janet Yellen articulated in her recent testimony before the Senate Banking Committee, should “stimulate a favorable dynamic in which jobs are created, incomes rise, more spending takes place.”

Along with its impact on interest rates, quantitative easing drives down currency valuations (which impacts imports and exports), increases inflation expectations, and increased equity valuations. Quantifying the exact impact of quantitative easing on equity valuations is difficult, but there are a couple of broad, observable forces at play.

First, it’s not called an easy-money policy for nothing. Combined with the zero-bound target federal funds rate, quantitative easing has helped reduce the cost of credit over the past few years, allowing corporations to borrow and spend. This is at the heart of the “favorable dynamic” that Yellen talked about in her congressional testimony. When corporations have access to cheap credit, they can engage in more business, which should boost profits. Increased corporate profits is manna from heaven for the equity markets.

Another factor, which is a little more dubious, is that the low interest rate environment has helped push investors looking for returns away from bonds and into stocks. This attitude can reinforce itself, as would-be investors observe strong gains in equity prices and want to get in on the action. More people buy into the market, which helps push prices higher.

Don’t Miss: 7 Ways Banks Failed Mortgage Settlement Compliance in 2013.

More from The Cheat Sheet