A flattening of the yield curve helped the fixed income markets to positive absolute returns in December, according to analysis by Ryan Labs.
Short rates out to two years were marginally higher, while intermediate and long yields declined by three to seventeen basis points. Dollar swap spreads actually were slightly higher in the short end and unchanged out the curve – as the curve followed Treasuries lead. Oil recovered a couple dollars, while the trade-weighted dollar index made new multi-year lows before bouncing into year end. The CRB index sold down 2.4% on the back of weaker energy, away from oil and soft commodities.
Corporate bond returns dominated the landscape with single A and BBB sector classes providing substantial excess returns versus their higher quality brethren. Excess returns for spread product were positive as spreads continued tighter for the seventh straight month. Mortgage and Asset Backed indexes produced total returns of 0.70% and 0.45% respectively for the month. The TIPS market index generated a return of 1.74%.
Non-farm payrolls for November came in light which served to provide the bid for the long end in the beginning of the month. Import prices and the PPI index both registered greater than expected increases. Pipeline inflation is fairly well evident at this point yet has not shown through to a great degree on the consumer side. As the Fed continues in its measured campaign of hiking overnight rates (now 2 %), the global pool of excess savings is serving to keep a lid on long rates. Fed Funds futures are discounting a 3% rate for year end, which would close the negative real rate gap in the short end. But, is the Fed being restrictive in generating liquidity or is it just raising the price of money? Repurchase and open market activity indicates the latter. The financial system is highly leveraged and would not be well served with a combination of higher cost money and less of it. 2005 should be a very interesting year.
Despite a year end rally in both the domestic and international equity markets (as measured by the S&P 500 and MSCI EAFE indexes, respectively), year-to-date Liabilities continued to outperform the weighted average asset allocation for a typical pension plan by -0.84% at year-end 2004. The distance widened in December as Liabilities surged 9.76% for the year. The Lehman index which represents investment grade fixed income underperformed its broad market equity counterpart by -6.47%.
The positive performance on the asset side during 2004 failed to narrow the funding gap of the average pension plan. The gap hovered at the same 75% funded level experienced at year-end 2003. Plan Sponsors may again need to contribute cash to defined benefit plans to repair deficits.