Graphic: Lower interest rates may boost fixed income, hurt private credit
A cut in interest rates in September seems to be a foregone conclusion, and chatter has turned to how aggressive an approach the Federal Reserve will take. Should longer-term yields continue declining, pension funds' U.S. fixed-income assets will likely benefit. However, private credit funds could see their outsized returns under pressure, since they typically tie their lending rates to short-term interest rates.
Fixed allocation: Large pension funds have a significant allocation to U.S. fixed-income assets. The class made up about 20% of the largest pension plans' assets, although that's down from the nearly 25% held in 2019.
Largest U.S. pension funds' fixed-income allocation
Dropping yields: 2- and 5-year Treasury yields peaked in October at 5.1% and 4.9%, respectively. They've dropped since due to economic data, including slowing inflation. The 2-year yield stood at 4%, and the 10-year yield was 3.96%, as of Aug. 7.
U.S. Treasury yields
Locking in yields: U.S. corporate high-yield bonds currently have a 7.71% yield to worst. Although down from nearly 10% at the end of the third quarter of 2022, it's high compared against the past 10 years. Investment-grade securities, represented by the Bloomberg U.S. Aggregate Bond index, have a 4.51% YTW. The YTW averaged 2.7% from 2014 through 2023.
Yields to worst
Private credit reversal? North American private credit funds have benefited from higher short-term interest rates, returning a cumulative 65.9% over the five years ended March 31. With the Federal Reserve poised to cut rates, though, returns could slow.
North American private credit vs. U.S. corporate high yield
*As of Aug. 7. Sources: Pensions & Investments, U.S. Department of the Treasury, Bloomberg, Preqin Pro