Pension360

Reporter Ed Mendel covered the California Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

After reaching agreements with all major creditors, San Bernardino is moving toward an exit from a four-year bankruptcy this fall without cutting public pensions, its largest and rapidly growing debt.

Last week U.S. Bankruptcy Judge Meredith Jury, saying the end is “in view,” scheduled another hearing June 16, when she plans to set a date for a hearing to confirm the exit plan, probably about 90 days later.

San Bernardino follows the path of previous bankruptcies in Vallejo and Stockton by limiting the main cuts in long-term debt to bonds and retiree health care, while raising taxes, slowly rebuilding reduced services, and leaving pensions untouched.

Now the prospect of cities and other local governments using bankruptcy to cut pensions or to get leverage in bargaining, which alarmed unions after Vallejo filed in 2008, may be fading as a pattern seems to be emerging.

Of the three cities that filed recession-era bankruptcies, San Bernardino had by far the strongest case for cutting pensions. The poorly managed city somehow seemed surprised to find that it was running out of cash and in danger of not making payroll.

After an emergency bankruptcy filing in August 2012, San Bernardino took the unprecedented step of skipping its legally required pension payment to CalPERS for the rest of the fiscal year, running up a tab of $13.5 million.

The California Public Employees Retirement System had grounds to cancel its contract with San Bernardino, likely resulting in pension cuts. But in mediation San Bernardino agreed to repay CalPERS with interest, $16 million, plus a $2 million penalty, all but $500,000 of which pays down city pension debt.

Part of the agreement announced in June 2014 was that the San Bernardino exit plan would not attempt to cut pensions. Four months later, a federal judge in the Stockton bankruptcy issued an opinion that a CalPERS pension can be cut in bankruptcy.

But even if the opinion had been issued before the mediated agreement, a lengthy San Bernardino disclosure statement heard by Judge Jury last week suggests that the city would not have attempted to cut pensions.

The San Bernardino disclosure gave the same basic reason as Stockton for not attempting to cut pensions in bankruptcy: Pensions are needed to be competitive in the job market, particularly for police.

“The city concluded that rejection of the CalPERS contract would lead to an exodus of City employees and impair the City’s future recruitment of new employees due to the noncompetitive compensation package it would offer new hires,” said the San Bernardino disclosure.

“This would be a particularly acute problem in law enforcement where retention and recruitment of police officers is already a serious issue in California, and where a defined benefit pension program is virtually a universal benefit.”

Apparently for the same reason, a pension reform approved by San Diego voters four years ago switched all new hires to 401(k)-style retirement plans, except for new police who continue to receive pensions.

If San Bernardino ended its CalPERS contract, Gov. Brown’s pension reform could speedup the feared exodus. To avoid being classified as “new hires” getting lower pensions, police and others choosing to leave the city would have to find another employer in CalPERS or a county system within six months.

“The departure of City employees upon rejection of the CalPERS Contract could be massive and sudden,” said the San Bernardino disclosure, which would “seriously jeopardize” public safety and other essential services.

San Bernardino does not provide federal Social Security for its employees. To remain competitive in the job market with a pension plan, said the disclosure, the city has “no ready, feasible, and cost-effective alternative” to CalPERS.

If San Bernardino did leave CalPERS, the city would have to pay for some type of new retirement plan while paying for pensions already earned under the CalPERS plan. The disclosure said the city would face a “hypothetical termination liability” of almost $2.5 billion.

And there would be a major legal battle. During mediation, said the disclosure, CalPERS took the position that its contract with the city cannot be rejected in bankruptcy or modified to reduce pensions and give the city financial relief.

When U.S. Bankruptcy Judge Christopher Klein issued an opinion in the Stockton case that CalPERS pensions can be cut in bankruptcy, CalPERS shrugged: the opinion is not legally binding and not a precedent.

In the Vallejo bankruptcy, city officials said they considered an attempt to cut pensions in bankruptcy but were dissuaded by a CalPERS threat of a long and costly court fight, possibly all the way to the U.S. Supreme Court.

Unions responded to the Vallejo bankruptcy by obtaining legislation, AB 506 in 2011, requiring cities, before filing for bankruptcy, to go through a 60 to 90-day process to try to reach an agreement with creditors or declare a fiscal emergency.

Stockton went through the “neutral evaluation” process before filing for bankruptcy on June 28, 2012. A little more than a month later San Bernardino filed an emergency bankruptcy on Aug. 1, 2012.

Under the San Bernardino exit plan, annexation of the city and its fire department by the county fire district is expected to yield a $143 parcel tax. City firefighters transfer to the county retirement system with no reduction in pensions. The city would continue to pay for previously earned CalPERS pensions.

In exchange for no cuts in pensions, San Bernardino got an agreement with a federally appointed retiree committee to eliminate a $112 per month retiree health care subsidy, saving the city $411,250 this fiscal year.

The disclosure shows the total annual San Bernardino payment to CalPERS is expected to increase from $14.2 million last fiscal year to $28.9 million by fiscal 2023-24.

In the latest CalPERS valuation, the safety plan for police was 76.2 percent funded with a debt or “unfunded liability” of $162.6 million. The annual employer rate of 44.8 percent of pay next fiscal year was expected to increase to 57.8 percent by fiscal 2021-22.

The CalPERS plan for miscellaneous employees was 78.1 percent funded with a $109.7 million unfunded liability. The annual employer rate, 26 percent of pay next fiscal year, was expected to increase to 34.4 percent by fiscal 2021-22.

Some pension costs are reduced, said the disclosure, through increased employee contributions, lower pensions for new hires under the governor’s reform, and contracting with private companies for solid waste removal and right-of-way cleanup.

A big step toward an exit plan was an agreement with Commerzbank to pay 40 percent of a $51 million pension obligation bond, up from the original proposal of 1 percent.

The judge was told last week that the city also has an agreement with 23 retired police officers who receive a supplemental pension through a private firm, the Public Agency Retirement System.

“We are not Detroit, we are not Stockton,” Judge Jury said in her concluding remarks last week. “We came into this case in a very different posture than the other cities. And therefore, the fact that it has taken us this long to get to confirmation was to be expected.”

Among large investors, pension funds are leading the way on mitigating climate risk in their portfolios, according to a recent study.

On the sidelines of the Milken Institute Global Conference on Monday CalSTRS CIO Chris Ailman spoke to Bloomberg about investing and climate change.

 

Video credit: Bloomberg

 

Whether through engagement, risk management or low-carbon investments, the largest pension funds in the world are leading the way on addressing climate risks, according to a new report from the Asset Owners Disclosure Project (AODP).

The same can’t be said for many of the world’s largest investors. In fact, AODP found that nearly half of the world’s 500 largest investors aren’t doing anything to address those risks.

AODP graded the world’s largest investors on the actions they’ve taken to mitigate the risk of climate change to their investment portfolios. The 10 highest-graded entities were all pension funds (see above chart).

More info on the laggards, from ai-cio.com:

Of the funds that scored the lowest on AODP’s index, the largest were predominately sovereign wealth funds from oil-producing nations and Asian insurers, including the Abu Dhabi Investment Authority, which manages approximately $773 billion, and Japan Post Insurance, worth $602 billion.

“I would encourage all of them to pick up the pace and ramp up their ambition in respect to a low carbon transition,” said Christiana Figueres, executive secretary of the UN Framework Convention on Climate Change. “It is the key to reducing risk and securing the health of their portfolios now and over the long term.”

[…]

AODP’s annual Global Climate 500 Index, which tracks the 500 largest funds in the world, found that 246 investors managing $14.3 trillion are doing nothing to address the investment risks related to climate change.

Read the full report here.

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Attracta Mooney of the Financial Times reports, The US public pensions crisis ‘is really hard to fix’:

Eighteen months after Rahm Emanuel, a former White House chief of staff, became mayor of Chicago, he addressed a news conference about his priorities.

“[Number] one is retirement security and pension reform so we can give taxpayers and the public employees retirement security, which is something we can’t say today,” the mayor said in November 2012.

In the following three and a half years, Chicago’s public pension system, which estimates suggest has a funding hole of between $20bn and $32.5bn, has cast a long shadow over the mayor.

There have been rows with unions, court battles and finally a credit downgrade for the city, all linked to the Chicago’s public pensions.

Similar stories are playing out across the US. Although the funding deficits might not be as extreme as in Chicago, many cities and states are struggling under the weight of their pension plans, which oversee the retirement incomes of current and past public sector employees.

The scale of this pension crisis, as it has been dubbed, is huge. The Hoover Institution, a think-tank at Stanford University, estimates that US public pensions collectively have a $3.4tn funding hole. More conservative numbers put the funding gap at around $1tn.

Few public pension plans are fully funded, meaning they do not have enough money to pay current and future retirees. And the situation is getting worse.

According to Wilshire Consulting, an investment advisory company, state-sponsored pension plans in the US had just 73 per cent of the assets they needed in mid-2015, down from 77 per cent in 2014. Turbulent market conditions in the latter part of 2015 and early 2016 probably made this number even worse.

The big questions are if and how the large funding holes that have emerged in the US public pension system can be fixed.

Chris Tobe, an investment consultant and author of Kentucky Fried Pensions, a book examining problems in Kentucky’s retirement system, says the shortfalls in most US public pension plans are fixable, but there are exceptions, such as Chicago.

However, fixing the schemes will require a lot of work and is likely to have unpleasant consequences for retirees, employees, taxpayers and politicians.

One area where this is apparent is when state and local governments increase or introduce taxes, using the money raised to plug pension shortfalls. Several cities, including Chicago and Philadelphia, have taken this route.

But higher taxes or the issuance of bonds, another option used by local governments to raise money in order to reduce pension deficits, often proves unpopular with taxpayers.

Tamara Burden, principal at Milliman Financial Risk Management, an investment adviser to pension funds, says: “Raising taxes and issuing bonds means a vote, and a lot of public entities have seen those initiatives not pass.

“[The large-scale underfunding of public pensions] is really hard to fix.”

In Chicago, Ed Bachrach, chairman of the Center for Pension Integrity, a non-profit organisation, estimates that to ensure the city’s pension plans are fully funded within 20 years, Chicago’s property tax would have to be increased 85 per cent. But he warns that “crippling tax increases” could drive taxpayers and businesses away.

Mr Bachrach adds: “In troubled jurisdictions, officials cannot raise taxes fast enough to prevent the erosion of fund assets, and the enormous pension payments required are crowding out expenditure for vital public services and crumbling infrastructure.”

There are other options available to improve the outlook for public pension plans. One is making changes within pension funds that would help to drive funding deficits down, such as cutting the fees retirement plans pay to asset managers. Some pensions are pushing into riskier assets in the hope that this will increase returns.

Alternatively, state and local governments could reduce benefits for current or future retirees, or cap the maximum retirement benefit that can be paid to an individual. These measures are illegal in some states and have proved unpopular with unions and public sector workers.

Public sector workers could also be forced to increase their contributions, or moved into defined contribution plans, which do not guarantee a level of income on retirement. This would, in turn, reduce the strain on local government budgets.

Any attempt to fix the pension shortfall is likely to involve a combination of these solutions. But there seems to be an unwillingness to fix the problems, according to Olivia Mitchell, a professor at the Wharton School at the University of Pennsylvania.

Unions, public sector employees and retirees do not want to give up the benefits promised to them, politicians do not want to impose tax hikes that could cost them votes, and taxpayers are reluctant to part with more cash to prop up the system.

Ms Mitchell says: “Politicians and taxpayers have shown themselves unwilling to take their public pension shortfalls seriously.”

Mr Bachrach adds: “Fixing this problem requires shared sacrifice from all parties: public employees, retirees and taxpayers. It requires courage on the part of elected officials.”

If the problems are not fixed, the consequences could be dire.

Some pension funds, including two of Chicago’s plans, are on course to run out of money within a matter of years. This means that either the retirees will not get paid the money they are owed, or, more likely, the cities and states that back the pension plans will have to cover the retirement payments.

This would leave cities and states with less money to spend on services such as education. In some cases, cities may go bankrupt. This has already happened in Detroit in Michigan and San Bernardino in California, where large public pension shortfalls contributed to the cities’ defaults.

“I do believe that US cities and towns will continue to suffer [because of their pension funding holes], and there will be additional bankruptcies following the examples of Detroit,” said Ms Mitchell earlier this year.

Some pension officials are hoping the federal government will step in and prop up problematic retirement funds. But Devin Nunes, a US Republican congressman, is trying to make sure this does not happen.

He proposed a bill in March to ensure the federal government cannot rescue insolvent public pension funds. “Cities and states should run [pension funds] in a financially sustainable way. That is what my bill encourages, particularly by prohibiting federal bailouts of distressed funds,” he says.

Even without the bill, Steven Hess, an analyst at Moody’s, the rating agency, says states and cities will have to fix their own pension problems. “We don’t think the federal government will come to the rescue of municipal plans,” he says.

Phil Angelides, a former state treasurer for California who used to sit on the board of Calpers and Calstrs, the US public pension schemes, says: “[The public pension deficit] is manageable if society begins to address it. A few pension funds may have immediate issues, but they face long-term challenges and there is still time to address them.”

As for Chicago, the future of its pension funds remains unclear. In March, Illinois’s Supreme Court ruled against Mr Emanuel’s plans to stabilise the pension funds by requiring larger employee contributions and cutting pension benefits in return for bigger contributions from the city.

In the wake of this ruling, a spokesperson for the mayor says: “We are currently evaluating a number of pension reform proposals.”

The mayor, it seems, faces an uphill battle to plug the city’s pension deficit.

US public pensions: ‘There is no young blood coming in’

The large funding holes that have emerged at US public pension plans have been decades in the making.

A combination of factors, ranging from demographics to current low interest rates, has left pension plans nursing big deficits.

In some cases, cities and state governments have not contributed as much as they should have to public pension plans, leaving funds without the money they needed to invest and plug any developing funding holes.

Another factor is that public pension plans have been underestimating how much money they would need in future, says Olivia Mitchell, a professor at the Wharton School at the University of Pennsylvania.

Public plans typically have high return targets of between 7 and 8 per cent, which are used to forecast how much money a pension fund will need to pay current and future retirees. Private sector pension plans, in contrast, typically use lower rates of 2.5 per cent on average to calculate future liabilities, says Ms Mitchell.

Every time a public pension plan misses the return target, their liabilities jump. They then need far stronger performance the following year in order to correct the problem.

An ageing public sector population is not helping matters. “There is no young blood coming in to keep their plans going,” says Ms Mitchell.

I’ve already covered why U.S. public pensions are doomed. It’s a slow motion train wreck and while demographics and historic low rates aren’t helping, in my opinion, terrible pension governance is equally if not a more important determinant of the U.S. public pension crisis.

Here are some of the points I noted on why this crisis isn’t going away:

The critical point to remember is that when rates are at historic lows, every drop in global long bond yields represents a huge increase in future liabilities for pensions. Why? Because the duration of liabilities is a lot bigger than the duration of assets which means that every drop in bond yields disproportionately impacts pension deficits.

This is why you see Canada’s large public pensions scrambling to buy infrastructure assets like London City Airport at a hefty premium. They need to find assets that are a better match to their long dated liabilities. We can argue whether Canada’s mighty pensions are paying too much for these “premium infrastructure assets” (I think so) but this is the approach they’re taking to defy volatile public markets and find a better suitable match for their long dated liabilities.

And unlike the United States, Canada’s large public pensions have the right governance to go out to do these direct investments in infrastructure. Also, unlike their U.S. counterparts, Canada’s large public pensions have realistic investment assumptions and are better prepared for an era of lower returns.

In the U.S., public pensions are delusional, firmly holding on to the pension rate-of-return fantasy. They’re also held hostage by useless investment consultants that shove them in the same brand name private equity funds and hedge funds. This doesn’t always pan out well for these public pensions but it enriches private equity titans and hedge fund gurus who collect outrageous fees no matter how well they perform.

It’s worth noting none other than Warren Buffett came out this weekend to state hedge funds are getting ‘unbelievable’ fees for bad results:

“There’s been far, far, far more money made by people in Wall Street through salesmanship abilities than through investment abilities,” Buffett said Saturday during Berkshire’s annual meeting in Omaha, Nebraska.

I couldn’t agree more. I don’t pity any hedge fund manager, especially those “superstars” managing multibillions, collecting a big management fee no matter how poorly they’re performing.

The amount of nonsense governing hedge fund investments at U.S. public pensions is a byproduct of a few things: 1) delusional public pension fund managers who don’t know the first thing about managing a portfolio off hedge funds and 2) this irrational thirst for yield at all cost believing that hedge funds can offer great risk-adjusted returns in all cycles.

Dan Loeb is right, we are in the ‘1st inning of  a washout in hedge funds’ and the reason is simple: deflation is coming, which means low rates and huge market volatility are here to stay. Most hedge funds are going to get obliterated in this environment and large public pensions are quickly realizing this which is why they’re redeeming from even brand name funds.

In Canada, large public pensions are increasingly looking to invest directly in infrastructure assets around the world and at home. I don’t see them chasing after hedge funds or even private equity funds which charge enormous fees and deliver lackluster results.

But in the United States, you don’t have the right pension governance, which means you can’t attract and retain qualified pension fund managers to bring assets internally to invest directly across public and private markets, as well as engage in internal absolute return strategies instead of farming them out and getting clobbered on fees.

Warren Buffett is right, there is a tremendous amount of salesmanship going on in Wall Street and fees matter a lot, especially over a long period. But U.S. public pensions remain undeterred, feeling that investing in hedge funds will help them navigate the future a lot better (they’re in for a nasty surprise).

Now, forget hedge funds, let’s talk about the pension fixes discussed in the article above. When a public pension is severely underfunded, either you increase taxes, emit more pension bonds, increase the contributions or cut benefits. Or you can pray that monetary authorities will resurrect global inflation and interest rates will shoot up and all these public pension deficits will magically disappear (a higher discount rate means lower future liabilities).

Unfortunately, I have bad news for pensions that believe higher interest rates are coming. I’ve been warning them for a long time of the deflation tsunami and that ultra low rates and the new negative normal are here to stay.

In fact, last week, Bank of Canada Governor Stephen Poloz warned pensions to brace for a new normal of lower rates. I would go a step further and tell pensions to brace for negative rates and truly understand what they are (Sober Look published a great comment looking at misconceptions surrounding negative rates).

Again, maybe I’m too negative, maybe oil will experience a multi-year bull run even if the Saudis are hedging their bets, maybe Jamie Dimon is right on Treasuries, maybe Soros is wrong and China’s pension gamble will pay off, maybe the yen’s surge won’t trigger another Asian financial crisis, maybe monetary authorities can resurrect global inflation and maybe the quants and algos can engineer ever higher stock prices so we can escape the Great Crash of 2016.

Or maybe the bulls are drinking way too much Koolaid because from my vantage point, nothing has changed on a structural basis to change my Outlook 2016 as to why the global deflation tsunami is coming and it will wreak havoc on global pensions (all the big moves in risk assets leveraged to global growth were related to weakness in the U.S. dollar which will change abruptly in the second half of the year as the rest of the world slows down big time).

Something else you should all bear in mind. All these pension fixes being proposed, whether it’s cuts to benefits, increasing taxes and contributions, or worse still, shifting them into defined-contribution plans, are all very deflationary.

But hey, if you believe in fairy tales and think the world is going to magically grow its way out of these problems, be my guest. I prefer reality which is why I think the big money in the second half of the year will be shorting all these risks assets leveraged to global growth that benefited from the (temporary) weakness in the U.S. dollar.

As far as fixing U.S. public pensions, the problem is huge, much bigger than U.S. policymakers can possibly grasp and there are powerful special interests who don’t want to change the status quo (basically hedge funds, private equity funds and the rest of the Wall Street mob milking public pensions dry).

In my humble opinion, if America wants a real revolutionary retirement plan, it has to stop looking at Wall Street for solutions and start bolstering Social Security by adopting Canadian pension governance and the risk-sharing model which is working all over the world.

That’s the brutal truth. There is no magic fix for what is ailing U.S. public pensions and the problem is going to get a lot worse over the next decade(s) and it will hurt the U.S. economy in profound ways.

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Andy Blatchford of the Canadian Press reports, Pensions should brace for new normal of lower neutral interest rates:

Bank of Canada governor Stephen Poloz is recommending pension funds get ready for a new normal: neutral interest rates lower than they were before the financial crisis.

Poloz told a Wall Street audience Tuesday that the fate of neutral rates — the levels he said will prevail once the world economy recovers — remain unknown, but they will almost certainly be lower than previously thought.

The central banker made the comment during a question-and-answer period that followed his speech on global trade growth.

Among the reasons, Poloz pointed to the more-pessimistic outlook for potential long-term global growth. The forecast was lowered to 3.2 per cent from four per cent, he said.

“That downgrade means the neutral rate of interest will be lower for sure — for a very long time,” said Poloz, who added it could go even lower if economic “headwinds” continue.

“Those in the pension business need to get used to it. They need to adapt to it.”

Since the 2008 global financial crisis, pension funds around the world have had to contend with market uncertainty, feeble growth and record-low interest rates.

Pension funds use long-term interest rates to calculate their liabilities. The lower the rates, the more money plans need to have to ensure they will be able to pay future benefits.

A December report by the Organization for Economic Co-operation and Development said the conditions have “cast doubts on the ability of defined-contribution systems and annuity schemes to deliver adequate pensions.”

To cushion the Canadian economy from the shock of lower commodity prices, Poloz lowered the central bank’s key rate twice last year to 0.5 per cent — just above its historic low of 0.25.

Poloz linked the higher neutral interest rates of the past to the baby boom, which he described as a 50-year period of higher labour-force participation and better growth.

“Well, that’s behind us,” Poloz told the meeting of the Investment Industry Association of Canada and the Securities Industry and Financial Markets Association.

“We don’t have numbers for all this, but you need to be scenario-testing those pension plans and the needs of your clients because the returns simply won’t be there.”

But with all the unpredictability Poloz said it remains possible current headwinds could convert into positive forces that would push interest rates back to “more-normal levels” seen prior to the crisis.

Earlier Tuesday, Poloz’s speech touched on another aspect of the post-crisis world.

He told the crowd they shouldn’t expect to see a return of the “rapid pace of trade growth” the world saw for the two decades before the crisis.

Poloz was optimistic, however, that the “striking weakness” in international trade wasn’t a sign of a looming global recession.

He said the renewed slowdown in global exports is more likely a result of the fact that big opportunities to boost global trade have already been largely exploited.

As an example, he noted China could only join the World Trade Organization once.

Poloz expressed confidence that most of the trade slump will be reversed as the global economy recovers — even if it’s a slow process.

“The weakness in trade we’ve seen is not a warning of an impending recession,” said Poloz, a former president and CEO of Export Development Canada.

“Rather, I see it as a sign that trade has reached a new balance point in the global economy — and one that we have the ability to nudge forward.”

He said there’s still room to boost global trade through efficiency improvements to international supply chains, the signing of major treaties such as the Trans-Pacific Partnership and the creation of brand new companies.

Poloz’s speech came a day after Export Development Canada downgraded its outlook for the growth of exports.

EDC chief economist Peter Hall predicted overall Canadian exports of goods and services to expand two per cent in 2016, down from a projection last fall of seven per cent.

Well, if President Trump takes over after President Obama, you can expect more protectionism and trade wars, which isn’t good for global trade.

But Bank of Canada Governor Stephen Poloz is absolutely right, pensions need to brace for a new normal of lower neutral interest rates. I’ve long warned my readers that ultra low rates are here to stay and if global deflation sets in, the new negative normal will rule the day.

Thus far, Canada has managed to escape negative rates but this is mostly due to the rebound in oil prices. If, as some claim, oil doubles by year-end, you can expect the loonie to appreciate and the Bank of Canada might even hike rates (highly doubt it). On the other hand, if the Great Crash of 2016 materializes, oil will sink to new lows and the Bank of Canada will be forced to go negative.

Interestingly,  on Wednesday, the Australian dollar plunged almost 2 per cent after a lower-than-expected inflation print  and deflation fears put a rate cut back on the agenda for next week’s Reserve Bank meeting. Keep an eye on the Aussie as it might portend the future of commodity prices, deflation and what will happen to the loonie.

You should also read Ted Carmichael’s latest, Why Does the Bank of Canada Now Believe that Fiscal Stimulus Works?. I agree with him, all this talk of fiscal stimulus is way overblown and in my opinion, it’s a smokescreen for what really lies behind the Bank of Canada’s monetary policy: it’s all about oil prices. And like it or not, the loonie is a petro currency, period.

[As an aside, Ted also shared this with me: “I’d be ok with the budget if they stuck with carefully thought out infrastructure with private sector and/or pension fund participation, but they have blown up the deficit with middle income transfers and operational spending.”]

The rise in oil prices alleviates the terms of trade shock and if it continues, the Bank of Canada won’t need to cut rates this year. It’s that simple, no need to torture yourself trying to figure out the Bank of Canada’s monetary policy, it’s all about oil, not fiscal policy.

South of the border, the Fed will do a cautious dance to avoid volatility:

The Fed is expected to do a cautious dance when it releases its statement Wednesday, as it leaves the door open for a rate hike in June but is not signaling one.

After two days of meetings, the Fed will release a 2 p.m. statement Wednesday. The statement is not expected to be much changed from its last one, but Fed watchers say the nuances will be important. There is no press conference where Fed chair Janet Yellen can provide further clarification, so markets will have only the statement to respond to.

The Fed is expected to be dovish in its statement, but the bond market clearly has been fearing it will be a bit more hawkish, and yields have been rising. Market expectations are for the next rate hike to come early next year, but the Fed has said it expects two rate hikes before then, so there is tension around any statement it would make.

“I don’t think they’re going to tip their hand on the policy section of it. I think the hawkishness might come in their description of the economy, because credit spreads have come back and are no longer a worry. The stock market is no longer down 10 percent on the year. Even the G-20 was less concerned about the economic outlook for the world,” said Chris Rupkey, chief financial economist at MUFG Union Bank.

But the U.S. economic data has been spotty, with more than a few misses recently. Durable goods was weaker than expected Tuesday, and first quarter GDP, expected Thursday, is predicted to be just barely positive.

Fed officials have also been sending mixed messages about rate hikes. For instance, Boston Fed President Eric Rosengren, viewed as a dove, has said the markets have it wrong and are not pricing in enough rate hikes.

“The problem is you’ve got disagreement. The gap has widened,” said Diane Swonk, CEO of DS Economics. “You’ve got dissents. When you have dissents, you have volatility.” Cleveland Federal Reserve President Loretta Mester is expected to join Kansas City Fed President Esther George in dissenting Wednesday, as they object to the Fed’s lack of rate hikes.

“I don’t think they can put the balance of risk back in, because they can’t agree what the balance of risks are,” said Swonk. “It just means continued uncertainty, continued uncertainty for the market.”

Michael Arone, chief investment strategist at State Street Global Advisors, also said the Fed is unlikely to suggest that risks are balanced.

“If they tell you it’s nearly balancing, that’ll be a signal that June is on the table,” said Arone, adding he does not expect to see that.

Arone said the Fed will want to leave options open. “I don’t think this Fed, and Yellen in particular, likes to paint themselves into a corner,” said Arone. “The statement will acknowledge that growth in the economy is modest. They haven’t seen the flow through to inflation and they’ll remain data dependent going forward.”

He said he will be watching to see if Yellen’s view is dominant in the statement. “My view is what Yellen did with her Economic Club of New York speech (March 29), she was saying: ‘I’m the chairperson. This is my view. We’re going to go slow and gradual.’ At the time, other Fed officials were talking about how April was still on the table,” Arone said. “I think what markets are going to be looking to see is if that remains the message or if we’re back in this kind of limbo.”

It will also be important to see if the Fed gives any nod to stability in international markets now that China has calmed some of the fears around its economy.

Besides the Fed, there is the trade deficit data at 8:30 a.m. EDT and pending home sales at 10 a.m. EDT. There is a 10:30 a.m. EDT government inventory data on oil and gasoline, and the Treasury auctions seven-year notes at 1 p.m. auction.

Earnings before the bell include Boeing, Comcast, GlaxoSmithKline, Mondelez, United Technologies, Anthem, Northrop Grumman, Dr Pepper Snapple, Nasdaq OMX, Nintendo, State Street, Tegna, Garmin, Six Flags and General Dynamics. After the bell, reports are expected from Facebook, PayPal, Marriott, SanDisk, Cheesecake Factory, La Quinta, Rent-A-Center, First Solar, Texas Instruments and Vertex Pharmaceuticals.

The only earnings that matter on Wednesday are those of Apple (AAPL). Its shares are down 7% at this writing as it feels the pain of the end of iPhone 6 cycle (they better come up with a great marketing campaign for iPhone 7 to bring the stock back over $120 this fall).

As far as the Fed, I don’t expect any major surprises today but who knows how markets react if the statement turns out to be more hawkish than expected.

More interestingly, Jeffrey Gundlach, the reigning bond king, visited Toronto recently and spoke with Financial Post reporter Jonathan Ratner. Here is an edited version of their discussion which you all MUST read as Gundlach talks about why debt deflation is a real threat, why the Fed capitulated in March and why negative rates are ‘horror’ (read this interview carefully).

Lately, Gundlach has been legging into Treasuries which shows you he’s not worried about any rout in the bond market.

So, if low rates are here to stay, how are pensions going to adapt? More hedge funds? Good luck with that strategy. More private equity, real estate and infrastructure? This seems to be the reigning strategy but pensions have to be careful taking on illiquidity risk, especially if global deflation sets in. And when it comes to private equity funds, they have to monitor fees and performance carefully and also realize real estate has its own set of challenges in this environment.

This is why in Canada, large public pensions are gearing up to bankroll domestic infrastructure, ignoring critics calling this the great Canadian pension heist. By investing directly in mature and greenfield infrastructure, Canada’s large public pensions can put a lot of money to work in assets that offer stable, predictable long-term cash flows, essentially better matching assets with their long dated liabilities without paying huge fees to private equity funds and without taking currency or regulatory risks (still taking on huge illiquidity risk but they have a long horizon to do this).

At the Berkshire Hathaway Inc. annual shareholders meeting over the weekend, Warren Buffett ripped into hedge funds and other investment vehicles associated with investment fees.

He specifically mentioned pension funds’ appetite for those vehicles.

From the Chicago Tribune:

After telling shareholders that he would offer “probably the most important investment lesson in the world,” he said Wall Street salesmanship has masked poor returns for years. Consultants, he added, have steered pension funds and others to high-fee managers who, as a group, underperform what you could get “sitting on your rear end” in index funds. The arrangements “eat up capital like crazy,” he said.

Buffett was building on an argument he’s been making for years about why backing U.S. businesses in aggregate, through low-cost funds, is the more certain way to prosper over the long haul.

[…]

Compounding the problem are middlemen who charge fees to pick managers, Buffett told shareholders.

“Supposedly sophisticated people, generally richer people, hire consultants. And no consultant in the world is going to tell you, ‘Just buy an S&P index fund and sit for the next 50 years,'” he said. “You don’t get to be a consultant that way, and you certainly don’t get an annual fee that way.”

That’s the key to the argument, said Richard Cook, a fund manager in Birmingham, Alabama, who made the trip to Omaha. Buffett still believes that some active investors can beat the S&P 500 over time, Cook said, but in a fund of funds “the fees on fees just destine you to lose.”

Hedge funds have experienced outflows of $16.6 billion over the last two quarters, according to Hedge Fund Research.