GLOBAL – A pension fund “feedback effect” could be behind the current puzzling low long-term yield situation says the Bank for International Settlements.

“The persistence of low long-term nominal yields in an environment of robust economic growth has puzzled many market participants and observers,” the BIS says in its latest quarterly review.

“One explanation sometimes offered is that demand from institutional investors, in particular pension funds, is exerting downward pressure at the very long end of the yield curve.

“This possibly reflects a feedback effect, whereby low interest rates encourage still more bond purchases by institutional investors.”

The BIS looked at the UK, saying it is “commonly acknowledged” the schemes trying to reduce asset-liability duration mismatches by buying ultra-long-term bonds has contributed to the fall in yields.

“But as yields have declined, pension funds’ liabilities have risen, increasing further the demand for long-dated paper and triggering further declines in yields,” the BIS said.

The bank also questioned whether such feedback elements are important in other countries.

It pointed to the Netherlands where the fixed interest rate had “so far permitted Dutch pension funds to operate with a relatively low asset duration of approximately six years”.

But it said: “Looking forward, differences between the UK and other systems may narrow, at least if proposals in the Netherlands and the US that include a greater reliance on (unsmoothed) market rates to discount future benefit payments are implemented.”

It was possible that pension funds in these countries had already altered their behaviour.

Although greater issuance of long-term bonds was one way to reduce the importance of feedback, the BIS warned that “there are limits to how much long-term debt governments and corporations can issue if they want to keep a balanced maturity structure of their liabilities”.

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