How Corporate Pensions Can Manage Today’s Economic Uncertainty

The macroeconomic outlook shifted swiftly in the first quarter. Following the election, markets focused on the potential for Trump administration policies to boost economic growth. But between January and March, investors increasingly focused on the risks associated with those policies. Risk markets reacted negatively, with equities falling and spreads widening across the fixed income spectrum.

The first quarter began with a continuation of the trend established at the end of 2024, as investors anticipated government policies that could increase both economic growth and inflation. The yield on the 10-year Treasury note rose 117 basis points from its September low through January 14, reaching 4.79%. Nearly half of that increase was reversed over the next eight weeks, as the 10-year Treasury yield fell 50 basis points.

This decline reflected a growing recognition that a variety of factors — including the escalating trade war, tighter immigration restrictions, federal government layoffs, and the US government’s fiscal situation — could weigh on economic growth. The possibility that some of these developments also are likely to be inflationary increased the potential for stagflation, which historically has been negative for both equities and fixed income.

Concerns about slowing growth and tariffs contributed to declines in US stocks. The S&P 500 fell nearly 9% between February 19 and March 12. Credit spreads widened as well after reaching their tightest levels in two decades. The ICE BofA High Yield Index Option-Adjusted Spread rose from 2.62 on February 18 to 3.20 on March 12, an increase of more than 20%.¹

While the environment deteriorated in the US, international equity markets experienced a bit of a renaissance. The MSCI EAFE index gained nearly 8% year-to-date through March 12, compared to a roughly 5% year-to-date loss for the S&P 500. Although the economic outlook is not significantly better outside of the United States, valuations outside the US were much lower. In addition, some of the policies raising concerns in the US — such as a pullback from the international stage — could be supportive of opportunities abroad.

We saw similar themes in the international fixed income markets. The ECB continues to cut rates while the Federal Reserve (the Fed) remains on hold, UK yields rose as US yields fell, and potential changes in Germany’s fiscal policy could lead to higher issuance and steepening yield curves. At the very least, a continuation of the deglobalization trend reinforces the benefits of international diversification.

Looking Ahead

The rising uncertainty around both economic growth and inflation has brought attention to the Fed's dual mandate to maintain stable prices and to pursue full employment. The Fed has focused on fighting inflation in recent years; this year we expect the Fed’s emphasis to shift to balancing the two goals. We continue to project three interest rate cuts, as inflation will continue to moderate over time, monetary policy remains restrictive, and the labor market could come under greater pressure. That said, our forecast for rate cuts could change as events unfold.

We anticipate that the US economy will continue to grow this year but may not accelerate the way many investors thought it might at the start of 2025. Likewise, we continue to hold a cautiously optimistic view for the equity and fixed income markets in 2025, tempered by an expectation for bouts of volatility in a period of policy transition. Although investor sentiment has retrenched, we have not seen signs of distress or panic. Selling has been orderly, and drawdowns have been moderate.

We expect yields on long-term government bonds to fluctuate as investors digest news related to inflation and growth. We continue to favor duration over credit spreads: US government bonds still benefit from safe haven status (which may be more attractive in a volatile world), while we believe that still-tight credit spreads limit upside. US corporations generally look healthy, with S&P 500 companies posting earnings growth of 18.3% in 2024.² That said, valuations are high in both the U.S. stock and corporate bond markets, and analysts have been revising first-quarter earnings forecasts downward.³ Greater macroeconomic uncertainty and a moderating outlook for earnings growth could hold back stock gains and push credit spreads higher. Times like these demonstrate the value of diversifying assets, including international equities and alternatives such as private credit.

Implications for Corporate Defined Benefit Plans

For corporate DB plans, these macroeconomic and market fluctuations increased the volatility of funded status. After four consecutive quarters of improvement, the Milliman 100 Pension Funding Index declined in February — falling to 104.8% from 106% at the end of January. For many plans, the outlook has shifted from optimism about growth assets and declines in the value of future liabilities to new concerns on both sides of the investing ledger.

Plans with especially high funding ratios and hedge ratios may be able to ride out these changes with only small adjustments to their liability hedging portfolios. For plans that are less well-funded or under hedged, we recommend looking for opportunities to extend duration and lock in higher yields that may emerge during times when markets react to inflationary pressures.

Plans looking to minimize funded status volatility in a more challenging environment may want to seek out diversifying sources of potential alpha. For example, systematic active fixed income (SAFI) strategies use quantitative inputs that seek to deliver excess return and can diversify fundamental active fixed income given low alpha correlations to fundamental active strategies.

Please contact our team if you have any questions about how to navigate an increasingly challenging macroeconomic environment.