It is sometimes said that “pension and insurance hedgers push the long end of the curve down” Explain how this happens and why- what are the connected steps? What do these players do and why? How does this result in curve moves? Also – how does this activity affect inflation curves?

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    $\begingroup$ Welcome to Quantfinance! Briefly, pension funds and life insurers have very long term liabilities, to hedge these they need to buy very long term assets (bonds). They push the market price of those bonds up and the yield down. $\endgroup$ – noob2 Feb 21 at 17:07
  • $\begingroup$ Some evidence and discussion of this is contained in this BIS paper of 2017 bis.org/publ/work519_economicreview.pdf $\endgroup$ – noob2 Feb 21 at 19:20

This is an issue for legacy Defined Benefit pension funds, that promise to pay a fraction of salary for time worked. Virtually nobody offers these schemes these days; but enough (usually older, and often public-sector) workers and retirees still have related entitlements thus.

These assets to the employee are obviously the liability of the employer's pension fund. The question is how these are valued, from an Asset/Liability Matching perspective. This can vary from country to country; but the general rule is that pension funds have to discount (and fund accordingly) based on regulator-specified longevity and discount rate assumptions.

These discount rates are usually very long-dated interest rates... so these represent a natural hedge for pension funds. Suppose that the 10y rate is say +1% and the 10y10y is say -1%, the 10y rate might be "riskier" to a pension fund than the 20y, even though the economics of this are clearly bonkers!!!

Regulation incentivises DB funds to receive long-dated rates at any price. This incentive can distort the price, because who is the natural seller on the other side of this pension tsunami?

  • $\begingroup$ to answer @demully final question it is typically corporates and governments who issue fixed bonds, or issue floating bonds and pay fixed on swaps to synthetically create fixed rate bonds. and also residential mortgages. But all of these are commonly found in the shorter end of the curve than at the longer end where the pension fund buyers/receivers hang out! $\endgroup$ – Attack68 Feb 22 at 20:04
  • $\begingroup$ Yeah OK @Attack68, it was meant to be rhetorical ;-) Govvie issuance is loaded in the belly; the long-end imbalance was supposed to be pension ALM in the absence of govvies extending their duration of issuance to meet this ;-) But I am condifent we both get it... all is AOK from my side.... $\endgroup$ – demully Feb 23 at 3:36
  • $\begingroup$ I know its rhetorical, and I know you know the answer, just providing info for someone that doesn't because it is not obvious. $\endgroup$ – Attack68 Feb 23 at 6:07
  • $\begingroup$ AOK, mon ami. So we both know that we both know ;-) In full transparency, governments tend to borrow with an average debt maturity of 5-10 years, with some but not much issuance ~20 years out. A "drop in the ocean" compared to the pension ALM demand. $\endgroup$ – demully Feb 23 at 8:34

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