Yesterday there were three pieces of news which in fact were interrelated even though they came from opposing sides of the Atlantic Ocean. Let me present them in chronological order.
The Executive Board of the Riksbank has decided to make monetary policy even more expansionary by cutting the repo rate by 0.15 percentage points to −0.25 per cent and buying government bonds for SEK 30 billion.
The (UK) Chancellor has announced that the government will extend its pension freedoms to around 5 million people who have already bought an annuity.
(Bloomberg) — Money-market futures traders cut the odds of a Federal Reserve interest-rate increase below 50 percent until December after Chair Janet Yellen lowered her outlook for growth and the pace of policy tightening.
These three apparently unrelated moves are in fact part of the trend to lower interest-rates and indeed bond yields that has been evident throughout my career. There have been ebbs and flows but the Status Quo has been this.
Get down deeper and down
Down down deeper and down
Down down deeper and down
Get down deeper and down
The Swedish Riksbank seems to have lost what little part of the plot it had retained and cut again against the bankground (background if you prefer) of a strong economy. Then if we move to the US Federal Reserve came a move which regular readers will know I was expecting. It removed the word “patience” from its report but then stepped backwards rather than forwards on the subject of a future interest-rate increase in the United States. One is coming soon or maybe later or maybe not at all as it desperately tries to mimic the boy or rather girl in this instance who cried wolf. Or in terms of Guns and Roses a bit more than a little patience will be required.
Said, woman, take it slow
It’ll work itself out fine
All we need is just a little patience
This is where the link between the UK and US news comes in. As well as the extraordinary drop in the US Dollar ( The UK Pound nearly made US $1.50 as traders were stopped out) there was a surge in US Treasury Bonds. The ten-year Treasury Note shot higher and the yield dropped through 2% to 1.92%. But it a way more important for this discussion we saw the long bond or thirty year rally two whole points as the yield dropped to 2.52%. The yield had been falling anyway as poor economic data continued to appear. Yes this weaker data was continually described as a “surprise” which those of you who have seen my exchanges on twitter with Newsnight economics editor Duncan Weldon may already have noted.
Those who listened to the Budget analysis on Share Radio would have heard me point out that Germany was at an all time high for bond prices and consequently low for yields. As I type this the ten-year yield has fallen to 0.19% according to MTS which is yet another high. Now if we move to the UK we are seeing the pressure build too especially now that the US is moving. Accordingly the UK Gilt market has rallied today and our ten-year yield is 1.55% and more to the point of today’s discussion the 30 year Gilt yields 2.36%. Both are hard to type for someone like me who has so much experience of much higher numbers.
These have a problem with such low interest-rates. Imagine for a moment an annuity provider in Germany for example looking to offering deals to people 2,5,10 and 30 years into the future. In the first two instances it faces negative bond yields so it would have to offer less than paid in. What a great deal! Moving forwards a 30 year yield on 0.65% offers very little return as the concept begins to implode.
The UK annuity market is not yet at that extreme but with a 30 year yield of 2.36% yields are really rather poor. Or to link matters virtually anyone who has taken out an annuity in the past will have got better terms than they can now. Of course many of them thought that they were getting poor terms! In essence annuity rates are the flip side of falling bond yields.
As an aside final salary pensions just got a little more attractive again or putting it another way we will see less and less of them in future.
Many with a pension scheme have found themselves facing this conundrum. From the Pensions Advisory Service.
Over recent years, annuity rates have fallen as we have moved into a low-interest rate environment and annuities have, consequently, become less popular.
Add that to an illustration showing you losing 3% per annum as discussed in the comments on here and no wonder pensions sometimes get a bad press!
If you crunch the numbers for a basic (single life no add-ons) annuity at age 65 then it takes around 17 years to get your money back. This is awkward and leads to the view that an annuity is bad value. The government heard the cries of “we would rather keep the money and spend it” and as it mulled the issue no doubt the thought that older people are more likely to vote saw it saw well why not let them?
There are two contrasting views on this. Firstly it frees people up to do what they want with fewer restrictions which is a good thing. However on the same road we see that there is the danger we are borrowing from the future one more time. We are doing that rather a lot these days and for the moment let us ignore the nightmare scenario that the money goes into buy to let investment in the UK property market.
What about existing annuities?
To a government the fact that there are around 5 million annuities must be tempting as of course they are in a population demographic which is likely to vote. They currently are as a group in “profit” as some will have terms vastly better than available now some a lot better and other simply better. No doubt someone somewhere has a loss but this will very much be the minority. Easy money?! Not quite as of course there is another side to the arrangement which is the pension or insurance company which will in generic terms have hedged its position in UK Gilts which will have bought corresponding gains. Oh hang on everybody cannot win! The circle is squared so to speak by the fact that the insurance company is losing on its annuity book compared to current values and prices. It is not even a zero sun game as the pension company will have set out to make a profit so it is in fact a negative sum game.
But our brave establishment knows no bounds in its efforts to borrow from the future or as it puts it give more freedoms! Accordingly we will in 2016 get this.
From April 2016, the government will remove the restrictions on buying and selling existing annuities to allow pensioners to sell the income they receive from their annuity without unwinding the original annuity contract.
Hooray so they can take their profit? If you think that please hold your horses and read my explanatory paragraph again. Here is the official version.
it allows the annuity holder to access the value of their property rights where they can find a willing buyer. The annuity provider would continue to pay the annuity payments for the lifetime of the annuity holder, but would reassign those payments to the purchaser.
So we are reminded that this is a personal contract dependent on an individual’s life. Time I think for Alice In Wonderland to help us out.
I can’t go back to yesterday because I was a different person then.
Why, sometimes I’ve believed as many as six impossible things before breakfast.
Putting it in more sophisticated terms perhaps then this reply to making my views known on twitter sums it up. From @NotGiacomo
@notayesmansecon you don’t think we should trust consumers to correctly price their own derivatives contracts?
Somewhere in this UK establishment version of Alice’s Wonderland the following scenario will play out. Grandad or Grandmother will sell their annuity and take the cash. Then they gift some money to their granddaughter Alice who needs some help to buy a house as she is struggling with her student debt burden. Alice will use the benefit of her university education to figure out that for every £100 she gets from the bank of Grandad/mother she will get another £25 from the UK Taxpayer.
have i gone mad?
im afraid so, but let me tell you something, the best people usually are.
If we move back to the pension changes and overlook the dangers of yet another misselling scandal, how many more times are they going to change the rules? I have the formal qualification from the Chartered Insurance Institute but threw away my textbooks the other day. In spite of being recently purchased they are relics of another era.
I wonder if I’ve been changed in the night. Let me think. Was I the same when I got up this morning? I almost think I can remember feeling a little different. But if I’m not the same, the next question is ‘Who in the world am I?’ Ah, that’s the great puzzle!