_{^{Q2 2024}}

Pension barometer

The Canadian bond market declined in the first quarter as bond yields moved notably higher. Canadian economic data delivered mixed results during the quarter—the labour and housing markets remained resilient, but this was offset by weakness in consumer spending and manufacturing activity. Meanwhile, the year-over-year inflation rate declined but remained above the Bank of Canada’s target level. These factors muddied the waters regarding a near-term interest-rate cut by the Bank of Canada and led investors to push back their rate-cut expectations, pricing in an initial interest-rate reduction for June rather than March.

These changing expectations led to a broad increase in Canadian bond yields during the quarter, resulting in lower bond prices. Sector performance was mixed—high-yield corporate bonds posted solidly positive returns for the quarter, while federal and provincial government bonds declined the most partly because of their relatively high level of interest-rate sensitivity.  

Canadian equities moved higher in the first quarter, continuing the rally that began in November 2023. The gains helped the S&P/TSX Composite Index touch an all-time high in late March and exceed the previous peak achieved in early 2022. The market was propelled by the same factors that lifted stocks worldwide, including favorable economic growth trends and expectations that the U.S. Federal Reserve and other central banks would begin to cut interest rates later this year. Canada’s economy exceeded expectations in January and February, with early data indicating that GDP is on track to expand 3.5% in the first quarter. While this could delay potential interest-rate cuts by the Bank of Canada, it also demonstrates that the economy has held up well in the face of tighter policy.

Stock markets worldwide turned in mixed returns in the first quarter of 2024. U.S. stocks, which account for about 70% of the MSCI World Index, posted strong gains, thanks to resilient U.S. economic growth, better-than-expected corporate earnings reports, and investor enthusiasm around artificial intelligence. Japan also turned in a robust return, as a weak yen bolstered the value of earnings from abroad. Conversely, European equity markets overall advanced but to a lesser extent, with some markets in decline and others up.

Canada yield curve

Source: Bank of Canada, Manulife Investment Management, as of March 31, 2024. 

In the first quarter of 2024, the average funded status increased to 130.0%, the highest level in recent history. Liabilities declined as bond yields moved notably higher over the quarter, whereas the average portfolio of assets generated a positive return over the quarter, leading to a healthier overall funded status. The current average funded status continues to be significantly higher than what it was in December 2020. 

Funded status of the average defined benefit pension plan in Canada

Source: PFaroe Moody’s Analytics 2023, as of March 31, 2024. 

The average asset mix represents a combination of growth, hedging, and diversifying assets, each playing a unique role in the functioning of the pension portfolio. The average asset mix below implies an interest-rate hedge ratio of 52.65%, relative to the interest-rate exposure of the average liabilities.² Based on Manulife’s Capital Market Assumptions, the average asset mix implies an expected return of 6.05%. Based on Manulife’s modelling and stress testing, there is a 95% probability that losses relative to liabilities will be less than 14.36%.  

Equity risk represents a large component of risk exposure for defined benefit pension plans. Therefore, a drastic downward move in equity prices has the potential to reduce a big portion of the surplus for the average defined benefit pension plan in Canada. A decrease in interest rates also has the potential to negatively affect the surplus for the average defined benefit pension plan, as it would lead to an increase in present value of liabilities.

The table below illustrates the impact certain market moves would have on the surplus status of the average defined benefit pension plan in Canada. 

Sources of relative risk for the average defined benefit pension plan

The chart below illustrates sources of relative risk for the average defined benefit pension plan. As shown in the chart, a fair amount or risk is diversified away, and along with significant equity risk, the average pension plan also has exposure to interest-rate risk, credit risk, and property risk.

Source: PFaroe Moody’s Analytics 2023, as of March 31, 2024. VaR refers to value at risk.

Solvency funded ratio

The chart below illustrates the solvency funded ratio of the average defined benefit pension plan across various scenarios, ranging from best case to worst case, forecasted all the way out to 2034. Based on our scenario analysis, the median forecasted solvency funded ratio for the average defined benefit pension plan in March 2025 is 132.8%, and in March 2034 is 133.6%.

Source: Manulife Investment Management, as of March 31, 2024.

In Canada, the economy is showing resilience in early 2024 but we continue to forecast a moderate economic contraction later this year. Facing elevated interest rates, households have started to pull back on spending. Pent-up demand and excess savings aren’t underpinning growth, and the mortgage refinancing schedule could lead to additional weakness on the consumption side. Core inflation has moderated markedly over the past two months, especially when discounting shelter costs. In the equity market, Canadian financial and energy firms have seen relative strength over the past couple of months. However, given the divergence between the U.S. and Canadian economies, we don’t expect the broader TSX index to outperform global markets this year.

Moving forward, the economic themes remain similar to what they have been over the last few months. The soft landing narrative—where inflation comes down and growth remains resilient—continues to be the consensus view across the investment world. Our team remains an outlier, as we continue to forecast a mild technical recession; however, the effect of GDP growth remaining slightly positive or moving slightly negative is unlikely to dramatically change the direction of markets.

What is important is understanding market expectations for growth, inflation, and interest-rate movements, and then the risk to those consensus expectations. As markets are expecting a soft landing, any surprise in the opposite direction (e.g., slowing economic growth or sticky inflation) could lead to increased market volatility. Either of those elements could also have a significant effect on interest rates. As of now, the global easing cycle has begun and rate cuts are expected from most global central banks at some point in 2024. The timing of those rate cuts is up for debate and the primary risk in the United States over the near term is rates remaining higher for longer.

Financial markets and their impacts on the pension industry are fast moving, and there's no one-size-fits-all approach. Our liability-driven investments and multi-asset solutions teams are here to help simplify markets and build strategies that work for you. Get in touch with us today to learn about how we can support your goals.