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Yields and Rates

As of October 31, 2009

Monthly and year-to-date recap

October was a relatively uneventful month for corporate bonds. While Treasuries edged higher, up 0.2% or so at the long end of the curve, continued compression of credit spreads offset this movement, leaving yields on high-quality corporates down just a smidgen on the month. Yields are some 2.5% lower than at the height of the financial crisis a year ago.

The chart below illustrates the significant steepening of the J.P. Morgan Aa Yield Curve and general decline in yields since the end of 2008, which is driving lower discount rates for virtually all pension plans, particularly those with shorter durations. The decline has come in the face of increasing Treasury yields this year, and reflects a reversion of credit spreads from historic highs experienced in late 2008 toward more "normal" spreads, as fears of an economic meltdown have receded.

Spot yield curve

The graph below compares curve spot rates at October 31, 2009 with those at December 31, 2008:

Effective discount rates

We have applied the curve to various model pension cash flows (short, medium, and long duration) and summarized the effective single discount rates for these plans currently and at selected historical dates below:

Bond data and par curves

The above curves were developed based on a universe of Aa bonds. The graphs below plot the bonds used as of October 31, 2009 and December 31, 2008. These plots are compared with par curves at each date to provide an intuitive sense of how well the curve fits the bond data.

At October 31, 2009, the curve was developed from data on 499 bonds with a total par value of $438 billion. This compares with 633 bonds and a total par value of $473 billion at December 31, 2008. While the number of bonds in the universe is lower than at the end of 2008, the total amount outstanding is still substantial, and the dispersion of yields within the Aa universe has declined significantly this year.

About the J.P. Morgan Aa Yield Curve

The J.P. Morgan Aa Yield Curve was created to serve as a tool to help employers determine and support a discount rate appropriate for the accounting of their pension and postretirement benefit plans under Financial Accounting Standards Board Statement Nos. 87 and 106.

The curve is based on a model developed by Cairns^[1].  The Cairns model fits an instantaneous forward rate curve to the bond data. From the forward rate curve, the spot curve, which is used to discount pension obligations, is derived at half-year intervals from 0.5 to 100 years. From this spot curve, a par curve is derived for purposes of assessing the fit with the original bond data.

The curve is based on a universe of bonds with the following criteria: US dollar denominated; rated Aa1, Aa2 or Aa3 by Moody’s or rated AA-, AA or AA+ by Fitch or S&P; fixed coupon; noncallable; nonconvertible; not index linked; and coupon frequency not “issued at a discount.” A small number of outlier bonds with unreasonable yields are removed each month.

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^[1] Cairns, Andrew J. G. (1997) Descriptive Bond-Yield And Forward-Rate Models For The British Government Securities’ Market