economists on Sunday predicted the Fed would cut rates, possibly before its next meeting, scheduled for March 16-17. In a note, Goldman economists Jan Hatzius and Daan Struyven said they expect a 50-basis-point cut at, or before, the meeting, and an additional 50-basis-point cut in the second quarter.
Fed Chairman Jerome Powell said Friday that the central bank is “closely monitoring” the outbreak. “We will use our tools and act as appropriate to support the economy,” he said.
The Goldman economists said they also expect rate cuts from the central banks of Canada, the U.K., Australia, New Zealand, Norway, India, South Korea and Switzerland, as well as the European Central Bank.
“Specifically, we see a high risk that the easing we expect over the next several weeks occurs in coordinated fashion, perhaps as early as the coming week,” the Goldman economists said. “Chair Powell’s statement on Friday suggests to us that global central bankers are intensely focused on the downside risks from the virus. We suspect that they view the impact of a coordinated move on confidence as greater than the sum of the impacts of each individual move.”
While the economists expect the Bank of Japan to stay pat on rates, it may still take action. On Monday, Bank of Japan Gov. Haruhiko Kuroda said in a statement that the central bank “will strive to provide ample liquidity and ensure stability in financial markets through appropriate market operations and asset purchases.”
, for example, went from an early 300-plus-point loss to a gain of more than 200 points late Sunday night. Last week, Wall Street suffered its worst losses since 2008.
The Goldman report tracks with a blog post published Sunday by Bill Nelson, chief economist at the Bank Policy Institute and a former Fed official, who said he expects a coordinated global effort to cut interest rates as soon as this week.
“There will be a coordinated easing across the major central banks and, possibly, the People’s Bank of China and the [Hong Kong Monetary Authority],” he wrote. “The cut will be substantial, at least 50 and possibly 75 basis points.” He predicted an announcement will be made Wednesday morning.
Due to declining treasury rates and tighter spreads, defined benefit (DB) plan sponsors are facing the lowest discount rates in the modern era. This has led to increased liability valuations, and thus lower funded status for many plans. This hurts the balance sheet and a variety of other measures that can influence the extent and timing of contributions, the level of Pension Benefit Guaranty Corporation (PBGC) premiums and whether risk transfer can be pursued. But to what extent will the recent fall in discount rates really impact sponsors? That depends on which measure you are focused on.
Sponsors are primarily concerned with corporate bond discount rates, as they are used in both funding and accounting calculations. However, since the introduction of pension funding stabilization1 in 2012, smoothing of discount rates over extended periods of time has become the norm for certain key funding measures. While providing sponsors with funding flexibility (albeit with corresponding PBGC penalties), funding stabilization has distinctly bifurcated corporate DB discount rates into two categories:
1. Smoothed/funding discount rates
These rates are used to determine contribution requirements and benefit restrictions.
At present, they are based on a 90% corridor below the 25-year average of IRS discount rates.
Currently, these rates are about 5.5% and decreasing each year in a predictable manner, as the 25-year average declines and future corridor expands.
2. Marked-to-market/accounting discount rates
These rates are used for balance sheet, pension expense and PBGC premium purposes.
As there is no smoothing of these rates, they are subject to significant volatility over time.
They are currently lower than 3% for many DB plans.
The following chart illustrates the pattern of these two discount rates over the last eight years, since funding stabilization was enacted.2
Funding and Accounting Discount Rates
Source: IRS, FTSE Pension Discount Curve
This chart makes clear the stark difference in predictability of the smoothed versus marked-to-market rates since 2012, but it also illustrates the large and persistent gap between the two measures. The average difference over this time horizon is about 240 bps and has ranged from 140 bps to 360 bps. While the smoothed rates have declined in a predictable fashion, marked-to-market rates have also declined – particularly over the last year.
Despite these lower rates, many sponsors may still claim to be fully funded, referring to their FTAP or AFTAP3 status, calculated by their actuary with smoothed discount rates. They often have no-or-negligible contribution requirements, and any PBGC premium may not receive attention, as it can be paid out of plan assets. But what would the equivalent funded status be using current marked-to-market rates? The difference can be significant.
Assuming for the moment that funding and accounting calculations use the same liability assumptions – except for the discount rate – let’s see how much lower a plan’s funded status can be, moving from one measure to another, for various liability durations.
Estimated underlying marked-to-market funded status
Funded status using smoothed rates
8-year liability duration
12-year liability duration
16-year liability duration
Source: Russell Investments, based on marked-to-market rates as of January 31, 2020
As you can see, the duration of the liabilities has a significant impact on the difference between the two measures. Note that if the accounting liabilities were to include future pay increases, the impact would be even more significant. It can be disheartening for a plan sponsor who is perceived to be 100% funded on one measure to really be as low as 70%. This has implications for PBGC premiums, additional filings and the effects of benefit payment drag.
Barring future changes to pension law, sponsors ought to be mindful of the coming phase-out of funding relief. With the ongoing decline in the 25-year average determined by the IRS, and the 90%/110% corridor expanding from 2021, the effects of funding relief will increasingly wear away. Contribution requirements will increase for many plans, bringing marked-to-market liabilities into economic reality.
As always, we stand prepared to help clients assess the associated implications for investment strategy and contribution policy into the future.
1. Introduced with MAP-21 in 2012 (The Moving Ahead for Progress in the 21st Century Act), then continuing with HATFA (Highway and Transportation Funding Act) in 2014 and BBA (Bipartisan Budget Act) in 2015.
2. This chart assumes a set of liability cash flows with a duration of about 12 years.
3. FTAP (funding target attainment percentage) and AFTAP (adjusted funding target attainment percentage) are used to determine a variety of DB-related implications, including benefit restrictions, quarterly contributions and contribution requirements.
Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.
Russell Investments’ ownership is composed of a majority stake held by funds managed by TA Associates with minority stakes held by funds managed by Reverence Capital Partners and Russell Investments’ management.
Frank Russell Company is the owner of the Russell trademarks contained in this material and all trademark rights related to the Russell trademarks, which the members of the Russell Investments group of companies are permitted to use under license from Frank Russell Company. The members of the Russell Investments group of companies are not affiliated in any manner with Frank Russell Company or any entity operating under the “FTSE RUSSELL” brand.
Mortgage rates are resting near record lows — and that’s spurring a wave of refinancing activity as Americans look to take advantage of the savings a cheaper interest rate could bring.
Refinance loan volume jumped to the highest level since 2013 last week, especially among jumbo mortgage borrowers, on the heels of lower mortgage rates, according to data from the Mortgage Bankers Association. The average interest rate for a 30-year fixed-rate mortgage fell to 3.45% last week, Freddie Mac
But refinancing isn’t foolproof. Taking out a new home loan can cost you thousands of dollars in fees. And making the wrong choices can significantly reduce your potential savings. Here are five questions homeowners should ask themselves before taking the plunge with a mortgage refinance.
How long will I stay in this home?
Mortgages are paid out over the span of many years, and during the initial period most of your payments will go toward the interest rather than the principal owed on the loan.
As a result, time is one of the most significant factors in determining whether a refinance makes financial sense. “You want to keep the loan long enough for the monthly savings to exceed the closing costs — that varies a lot depending on the fees,” said Holden Lewis, mortgage expert at personal-finance website NerdWallet.
Homeowners who are planning to move to a new house in the next five or so years may actually save more by sticking with their existing mortgage rather than refinancing, given the fees you have to pay the lender.
‘You want to keep the loan long enough for the monthly savings to exceed the closing costs.’
On the flipside, people who are in their forever homes could benefit from taking out a 15-year loan rather than a 30-year loan, Lewis said. The average interest rate on the 15-year fixed-rate mortgage is typically lower than the 30-year loan — it currently stands at 2.97%. So while these loans require larger monthly payments, the aggregate savings are greater.
A 15-year loan also would allow the homeowner to build equity faster, which they could then tap through a home-equity loan further down the road if unexpected expenses arise.
How much will I save?
To save money with a refinance, the general rule of thumb is that the new interest rate needs to be 50 basis points lower than your current one, Kapfidze said. But when looking at the average rates reported by Freddie Mac, it’s important to remember that the rates offered by lenders can be even better.
“Because typically a lot of the rates you see are average rates, it means that half the rates are below that,” Kapfidze said.
To save money with a refinance, the new interest rate should be 50 basis points lower than your current one.
Comparison shopping, as a result, is critical in order to score the best deal. Lenders don’t just compete on interest rates. They also can adjust how much you spend in closing costs. Another factor that can shift overall savings is the discount points — these are fees lenders collect at closing in order to reduce the long-term interest rate. If you can pay more at closing, this could bring your interest rate down even further.
Am I paying mortgage insurance?
There are two instances when borrowers must pay mortgage insurance: If they get a Federal Housing Administration (FHA) loan, or if they get a conventional loan with a down payments of less than 20%.
When refinancing, it’s critical to review what type of loan you can get and how much equity you have. “Refinancing when you’re going to have 20% equity or more is going to give you the best deal because you’re not going to have mortgage insurance,” Lewis said.
Getting rid of mortgage insurance will boost your overall savings and can make a refinance worth it even if you’re outside the 50-basis-point threshold.
If you haven’t built much equity in your home through your monthly mortgage payments, but have a chunk of cash in savings, a cash-in refinance can help push you above the 20% mark, Kapfidze said, adding that this could be a decent use of your tax dollars.
‘Your better credit score will put you into a better rate.’
Is my financial house in order?
A recent study from LendingTree found that one in four mortgage refinance applications is denied. The most common reason applications are denied is that the borrower’s debt-to-income ratio is too high, followed by having poor credit.
Taking steps to improve both your debt-to-income ratio and your credit score ahead of applying for a new home loan will increase the odds of getting improved. “If there’s anything you can do to reduce your non-mortgage debts, that’s going to help,” Kapfdize said. It’s also important to verify that there are no errors on your credit report.
Another reason to review your credit history: Your score has likely improved as you’ve been paying off your mortgage. “Your better credit score will put you into a better rate,” Kapfidze said.
When pursuing a refinance, don’t forget about your existing lender. “If they know you’re shopping around, they should be motivated to give you the best deal,” said Rick Sharga, a mortgage industry veteran and consultant.
Because your existing lender already has your personal information and payment history, refinancing with them can often be an easier process. Additionally, they have a vested interest in keeping your business, which will push them to compete as much as possible with other lenders’ offers.
Another way refinancing with your existing lender can mean better savings is by amortizing the new loan. Your lender will have a sense of how long you’ve had your existing loan for, and as a borrower you will save more by refinancing to a shorter duration than getting a new 30- or 15-year loan and starting from square one.
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