Bob’s Journal for 10/5
The Rising Risks in Treasury Bonds
Actions by the Federal Reserve often have unintended consequences. Treasury bonds have been hit and will continue to suffer from the unintended consequences of the Fed’s actions of the past few years.
In the 1980s, a number of people warned about what they called the “hockey stick” built into the federal budget. They said interest payments made by the federal government would be relatively stable for a period, but then continued increases in federal debt would cause interest payments to skyrocket to the point they would consume a large percentage of the budget.
The hockey stick phenomenon didn’t happen for decades, largely because the Fed kept interest rates near zero. But easy money eventually triggered high inflation. In 2022, the Fed had to tighten the money supply and raise interest rates.
In a short time, the rate the U.S. Treasury pays on its 10-year bond went from around 0% to over 4.7% this week. Also, interest rates on shorter-term debt now are higher than on longer-term debt.
With the Fed out of the bond-buying business for now, the U.S. Treasury has to let interest rates on its bonds rise to attract enough buyers.
The Treasury issues fixed-rate debt, so the higher rates are only paid on new bond issues. But the arithmetic for the future isn’t attractive, or as The Wall Street Journal recently said, it’s scary.
The Congressional Budget Office recently estimated that this year interest paid on debt held by the public will amount to about 75% of discretionary, nondefense spending. Interest payments will equal 100% of discretionary, nondefense spending by 2031.
A number of budget analysts believe the CBO’s projections are optimistic.
In addition, higher interest rates affect everyone else in the economy. They’re great for savers who want conservative investments that pay attractive yields.
But higher rates aren’t good for businesses or buyers of long-term assets such as homes and cars that usually are financed with debt.
Higher rates also aren’t good for those who bought bonds before rates rose. They’re now looking at paper losses on the bonds.
As I’ve said before, banks were major buyers of bonds when rates were low and now have big losses on their bonds. That impairs their capital and ability to make loans.
These effects are why I’ve been recommending against bonds and other interest-rate-sensitive investments for the last few years. They’re also among the reasons I’ve been cautious about stocks.
While the Fed soon might be done raising its interest rates, it isn’t going to adopt an easy money policy in the near term. Market forces will continue to push interest rates higher, and that will have negative effects on stocks, bonds and the federal budget.
There’s a New Plan Being Developed to Fix Social Security
The Social Security retirement trust fund is projected to run out of money around 2033, according to the latest estimate from the program’s trustees.
I’ve been saying for more than a year now that, when Congress finally decides to act, it won’t opt for the expected combination of tax increases and benefit reductions. Congress has waited too long. The numbers are too big now, so the changes needed would be too severe.
My expectation has been that Social Security would stop being a self-supporting program. Congress would begin to fund the shortfall from general revenues.
A bipartisan group in Congress has been working out of the public eye to address Social Security’s problems. The group has been developing an interesting variation of this approach, according to a recent article in Barron’s.
The plan, which still is in development, would involve the federal government borrowing about $1.5 trillion over five years. The money would be put into a fund run by professional managers selected by Congress and the President. The managers would invest the money in low-cost index funds and other low-cost stock investments.
These would be long-term investments. The expectation is that over time the stock investments would earn a return about 3.5% higher than the interest rate paid to borrow the money. The excess returns would be used to make up the Social Security shortfall.
Of course, there would be bear markets when the fund would lose money. But if the future is anything like the past, over time returns from the stocks would exceed the cost of borrowing the money.
The profits from the fund would erase about 75% of the projected Social Security shortfall. The rest of the deficit could be made up from a palatable combination of tax increases and benefit changes.
The plan still is in development. Even after the working group is satisfied, there probably won’t be any public proposal until after the 2024 election.
Check Your Estimated Tax Payments
Estimated taxes, and the penalties for not making them, are a financial burden to many retirees. The situation is becoming worse.
Most people have income taxes withheld from compensation during their working years. But automatic withholding stops at retirement.
You still have to prepay income taxes during the year. One way to prepay the taxes after retirement is to arrange to have them withheld from any regular payments you receive, such as annuities, pensions and IRA distributions.
The other way, which most retirees have to use to prepay at least part of their taxes, is to make estimated tax payments four times a year.
Many people overlook their estimated tax payments. Or they make them late. Others make the payments but don’t prepay enough to avoid penalties.
The IRS has been sure to capture the interest and penalties from incorrect estimated tax payment mistakes.
Estimated tax penalties imposed increased 42% from 2012 through 2017. They increased another 24% from 2017 to 2022, according to data recently issued by the IRS.
More retirees are likely to be hit with underpayment penalties this year because interest rates have increased so much since 2021.
Bank accounts that used to pay insignificant interest in the past now are earning meaningful interest. Also, many investors moved money out of low-interest accounts or risky investments into money market funds and other vehicles that pay steady interest at rates of 5% or so.
Review the estimated taxes you paid so far in 2023. Also, review the income you’ve received and how it compares with last year’s income.
If your estimated tax payments are falling short of the amount needed to avoid penalties, there’s a trick to consider.
Estimated taxes are supposed to be paid evenly during the year. You can’t avoid the penalties by making a large payment near the end of the year or in the final payment due by Jan. 15.
But any taxes that are withheld from income are considered paid evenly throughout the year, even if a large amount was withheld near the end of the year.
A strategy is to take a large distribution from a traditional IRA or some other source. When arranging the distribution, request that enough be withheld for income taxes to help you avoid underpayment penalties for this year. Most IRA custodians and other financial services providers will withhold taxes at your request at no charge.
Estimated tax penalties can be stiff. It’s worth your while to be sure you aren’t subject to the penalties.
The Data
Personal income increased 0.4% in August following a 0.2% rise in July. Compensation to employees jumped 0.5% in August.
Personal spending also increased 0.4% in August after rising 0.9% in July. After adjusting for inflation, real personal consumption expenditures grew only 0.1% in August, following a 0.6% increase in July.
The Fed’s preferred measure of inflation, the Personal Consumption Expenditures (PCE) Price Index, increased 0.4% in August following a 0.2% rise in July. Over 12 months the PCE Price Index increased 3.5% through August, up from 3.4% through July.
Excluding food and energy, the core PCE Price Index was up 0.1% in August, which is down from the 0.2% increase in July.
Over 12 months, the core PCE Price Index rose 3.9% through August after rising 4.3% through July. August marked the lowest level for this measure since May 2021.
The final Consumer Sentiment Index for September from the University of Michigan was 68.1. That’s higher than the mid-month level of 67.7 but lower than the 69.5 at the end of August. The index hit a recent high of 71.6 in July.
The ISM Manufacturing Index rose to 49 in September from 47.6 in August.
The ISM Services Index for September was 53.6, down from the six-month high of 54.5 in August. September was the ninth consecutive month and the 39th in the last 40 that the index was above 50.0, indicating the sector was expanding.
The PMI Manufacturing Index increased to 49.8 in September from 47.9 in August.
The PMI Services Index fell to 50.1 in September from 50.5 in August.
The PMI Composite Index for the economy held steady at 50.2 in September.
The Kansas City Fed Manufacturing Index was negative 13 in September, down from positive 12 in August. That’s the seventh negative reading for the index in 2023.
Factory orders increased 1.2% in August after declining 2.1% in July.
After excluding transportation, which is considered a good measure of business investment, orders increased 1.4% in August after rising 0.9% in July. The August number reached the highest level for this measure since March 2022.
Pending home sales declined 7.1% in August after increasing 0.5% in July. Over 12 months, pending sales are down 18.7% through August after being down 14.3% through July.
The third and final estimate of gross domestic product (GDP) growth for the second quarter was unchanged from the second estimate that the economy grew at an annualized rate of 2.1%. In the first quarter, GDP grew at a 2.2% rate.
Only 89,000 new private sector jobs were created in September, according to the ADP Employment Report. That’s the lowest number since January 2021.
There were net losses in the number of jobs at large employers but strong gains at small and mid-size employers. Annual wage growth slowed for the 12th consecutive month and was 5.9% in September.
The number of job openings increased by 961,000 in August to 9.61 million, according to the JOLTS (Job Openings and Labor Turnover Survey) report. That’s the first monthly increase in job openings since April.
The number of people quitting jobs in August increased by 19,000 to 3.638 million. But July’s number of people quitting jobs was revised down to a two and one-half year low.
The percentage of workers quitting jobs in August was at the lowest level since January 2021.
New unemployment claims increased by 2,000 to 204,000 in the latest week.
Continuing claims, which lag a week behind new claims, decreased to 1.670 million from 1.658 million.
The Markets
The S&P 500 lost 1.01% for the week ended with Tuesday’s close. The Dow Jones Industrial Average fell 1.80%. The Russell 2000 declined 1.85%. The All-Country World Index (excluding U.S. stocks) decreased 2.22%. Emerging market equities retreated 1.32%.
Long-term treasuries fell 3.98% for the week. Investment-grade bonds lost 2.55%. Treasury Inflation-Protected Securities (TIPS) decreased 1.17%. High-yield bonds declined 1.43%.
In the currency arena, the U.S. dollar rose 0.87%.
Energy-based commodities lost 1.33%. Broader-based commodities dropped 1.85%. Gold declined 4.03%.
Bob’s News & Updates
My latest book is “Retirement Watch: The Essential Guide to Retiring in the 2020s.” Learn more and order by clicking here and here. You can be among the first to write a review.
My previous book, “Where’s My Money: Secrets to Getting the Most out of Your Social Security,” is receiving mostly five-star reviews on Amazon for telling you clearly what your benefit options are in different situations and how to determine the best choice for you. You can find it on amazon.com or Regnery.com.
The number of regular viewers for my Retirement Watch Spotlight Series continues to increase. You should sign up because I make in-depth presentations of key retirement finance topics. You can watch these online seminars from the comfort of your home or office at times you choose. To learn more about my new Spotlight Series, click here.
A recent five-star review of my book, “The New Rules of Retirement” on amazon.com said, “A complete retirement guide! One of the best books on this topic!” Click for more details about the revised edition of “The New Rules of Retirement.”
If you’re interested in my books, check my amazon.com author’s page.
I’m a senior contributor to the Forbes.com blog. You can view my contributor page here.
