Bob’s Journal 2/6

The Fed Cuts, But Interest Rates Rise

The Federal Reserve started reducing the interest rates it controls in September 2024. But the interest rates that the markets control, and that matter more to businesses and investors, steadily increased.

The yield on the 10-year Treasury bond hit a recent low of 3.63% on September 16, 2024.

It hit a recent high of 4.78% in mid-January before dipping a bit to 4.52% this week.

At the same time, the Fed Funds Rate dropped from 5.33% in September 2024 to 4.33% recently.

Though it surprises many, it isn’t unheard of for longer-term interest rates to rise when the Fed is cutting its short-term rates.

The Fed usually reduces interest rates when it is worried about slow economic growth and wants to avoid or lift the economy out of a recession.

In 2024, the Fed took the rare step of reducing interest rates when the economy was growing, and inflation was above the Fed’s stated target.

Investors worry the Fed acted too quickly and reduced interest rates too much. They fear that it could reignite inflation.

The large federal budget deficits that now appear to be perpetual also concern investors. Governments with excess debts often pay those obligations through inflation. They pay their debts with currency that has reduced purchasing power.

Investors who are concerned about the federal debt believe intermediate- and long-term market interest rates hit lows last year that aren’t likely to be revisited. Rates might steadily increase in coming years.

There are analysts who disagree. They think inflation will continue to decline and the government will be able to manage its debt levels. Morgan Stanley, for example, recently projected that the 10-year treasury yield will be 3.55% by the end of 2025.

Investors who agree with Morgan Stanley should consider locking in current yields by buying treasury bonds or longer-term CDs or multi-year guaranteed annuities. They also might want to consider some leveraged closed-end funds that hold bonds and would benefit from lower interest rates.

I think much lower yields on bonds and similar vehicles are unlikely and won’t last for long if they happen. For example, the yield on the 10-year treasury dipped in the fall of 2024, but reversed course in December.

Short-term vehicles with principal protection have yields close to those on the 10-year treasury, and the Fed announced it wasn’t going to reduce interest rates further for at least a while.

Those are good reasons to be cautious about locking in today’s yields.

Keep an Eye on Rising Medical Expenses

Medical costs are soaring, and you need to factor that into your financial plans.

In its latest earnings report, Cigna said almost 88% of the premiums it collected were paid to medical providers of its insured customers.

That is the highest percentage of premiums paid to medical providers by a large margin. Historically, for most major health insurers in the U.S., the percentage of premiums that go to medical providers is between 80% and 84%.

Other major health insurers are reporting similar results.

There are several factors behind this change.

A major factor that I began reporting in 2024 is that Medicare Advantage plans are costing more than the insurers anticipated. That’s due to a combination of lower government reimbursements and policyholders using more medical services than expected.

Insurers’ costs for prescription drugs also are increasing as a result of the Inflation Reduction Act.

It also appears that hospitals are performing more expensive procedures than in the past.

You should pay attention to this for several reasons.

If you own medical insurer stocks or a fund that has a significant allocation to them, these trends are having a negative effect on your portfolio and will continue to do so unless the trends reverse.

The trends also are making Medicare Advantage plans less attractive, as I’ve pointed out in the past. There are fewer plans available, and those plans have higher costs and lower benefits than in the past.

The changes also are making medical insurance in general more expensive, including Medicare supplement policies and Part D prescription drug policies.

Finally, the federal and state governments pay significant shares of the country’s medical expenses through Medicare and Medicaid. Higher medical expenses are likely to increase federal spending and budget deficits, as well as increase pressure to change the terms of the programs.

You should factor rising inflation for medical expenses and insurance premiums into your long-term financial plans.

Congress Increases Social Security Benefits for Some State and Local Government Employees

In a move towards the end of the last Congress, the Social Security Fairness Act was enacted.

The law repealed two provisions that were created in the 1983 Social Security reforms, the government pension offset and the windfall elimination provision.

The provisions were enacted because analysts determined that under the old rules, workers who spent part of their careers in the private sector covered by Social Security and part in state and local government jobs that weren’t covered by Social Security were receiving inflated Social Security benefits.

Last year, Congress decided to repeal those provisions and retroactively increase the benefits of people who were affected by them.

The change will cause the Social Security trust fund to be depleted faster than previously estimated and increase the amount of benefits paid each year.

Of course, the workers affected will receive higher benefits. Some who have been receiving benefits will receive lump sums of retroactive benefit increases.

The Social Security Administration said recently that it could take more than a year to adjust current benefit payments and pay the retroactive benefits.

SSA says the adjustments are complex and its systems require a case-by-case analysis with much of the work done manually. The law didn’t provide additional funding for staffing or for the benefit payments. About three million people are estimated to be affected by the changes.

Only workers who receive a pension based on work that wasn’t covered by Social Security (they didn’t pay Social Security taxes) are affected.

The SSA published online some details of the transition in a question-and-answer format. The webpage is updated as the SSA has new information.

Anyone who is affected or thinks they might be affected by the new law should visit the webpage to learn what, if anything, they should do now and expect in the future. They should revisit the webpage regularly to determine if new information has been published.

The Data

The ISM Manufacturing Index was 50.9 in January, up from 49.2 in December. The index had been below 50 for 26 consecutive months. A reading of 50 or above indicates the sector is expanding, while a lower reading indicates it is contracting.

The ISM Services Index dropped to 52.8 in January from 54.0 in December.

The PMI Manufacturing Index in January was 51.2, compared to 49.4 in December. This is the first time this index has been above 50 since June 2024.

The PMI Services Index declined to 52.9 in January from 56.8 in February.

The PMI Composite Index for the economy fell to 52.7 in January from 55.4 in February.

The Personal Consumption Expenditure (PCE) Price Index increased 0.3% in December following a 0.1% increase in November. The 12-month increase in the PCE Price Index was 2.6% through December and 2.4% through November.

The core PCE Price Index, which excludes food and energy prices, was up 0.2% in December and 0.1% in November.

The 12-month increase in the core PCE Price Index was 2.8% through both December and November.

Factory orders fell 0.9% in December, following a 0.8% decline in November.

A good proxy of business investment is factory orders minus transportation orders. That measure increased 0.3% in December and 0.2% in November.

Pending home sales tumbled 5.5% in December after increasing 1.6% in November. December broke a streak of four consecutive months of increases in pending home sales.

Pending home sales in December were 5.0% lower than 12 months earlier, which compares to a 6.9% increase in November.

The first estimate of fourth-quarter gross domestic product (GDP) indicated the economy increased at an annualized rate of 2.3% in the quarter. That’s down from 3.1% for the third quarter and is the slowest rate in three quarters.

The ADP Employment Report estimated that 183,00 new private sector jobs were created in January. That’s an increase from the 176,000 jobs created in December.

The number of job openings in the United States declined by 556,000 to 7.6 million in December, according to the JOLTS (Job Openings and Labor Turnover Survey) report. The only month since early 2021 with fewer job openings was September 2024.

New unemployment claims fell by 16,000 to 207,000 in the latest week.

Continuing claims, which lag a week behind new claims, decreased to 1.858 million from 1.900 million.

The Markets

The S&P 500 fell 0.45% for the week ended with Tuesday’s close. The Dow Jones Industrial Average lost 0.64%. The Russell 2000 increased 0.08%. The All-Country World Index (excluding U.S. stocks) added 0.52%. Emerging market equities advanced 1.62%.

Long-term treasuries gained 0.63% for the week. Investment-grade bonds increased 0.12%. Treasury Inflation-Protected Securities (TIPS) added 0.45%. High-yield bonds gained 0.11%.

On the currency front, the U.S. dollar rose 0.14%.

Energy-based commodities increased 0.44%. Broader-based commodities gained 2.46%. Gold advanced 2.89%.

Bob’s News & Updates

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I’m a senior contributor to the Forbes.com blog. You can view my contributor page here.