The term premium for 10-year Treasuries has increased 75 basis points (bps) over the past three months, see chart below.

In other words, 10-year rates have increased an additional 75 bps more than what can be justified by changing Fed expectations, which is likely a reflection of emerging fears in markets about US fiscal sustainability.

Combined with the significant decline in the Fed’s Reverse Repo Facility (RRP) usage and the dramatic increase in T-bill issuance in 2024 (which needs to be rolled over into longer duration), the risks are rising that rates markets will be more volatile in 2025.

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The average daily rate for a hotel in New York is at a record-high of $417, see chart below.

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The US and European business cycles are decoupling, it is highly unusual, see chart below.

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The housing stock in the US is getting older, and the median age of a home is now 40 years, up from 31 years in 2005, see chart below.

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The latest CFO survey by Duke University and the Federal Reserve Banks of Richmond and Atlanta shows rising optimism regarding the economy and their own company, see chart below.

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The finance textbook says that investors should diversify their investments. But there is little diversification today when buying the S&P 500. The combined weight of stocks with a weight of 3% or more in the S&P 500 index is at an all-time high and continues to rise, see chart below.

The bottom line is that buying the S&P 500 gives the impression that you are buying 500 different stocks and diversifying your investments. But the reality is that the high and growing concentration in the S&P 500 continues to be a major problem.

In short, investors should ensure that their portfolio is not all levered to Nvidia earnings.

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Autos are usually one of the most interest-rate-sensitive sectors in the economy. When the Fed raises interest rates, you would expect car sales to decline.

But that is not what has happened during this cycle.

Instead, car sales have been going up despite the Fed raising interest rates from zero to 5.5% over a short period.

The source of strong demand for cars has been robust income growth, low unemployment, households having excess savings after the pandemic, and significant increases in stock prices and home prices, leading to a higher share of cars purchased with cash.

Combined with the Fed now cutting interest rates, the outlook for car sales continues to be strong, see also the steady increase in car sales since the Fed began to cut interest rates in September.

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Below is a list of risks to markets in 2025, including the probability that each risk materializes.

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Total employment in the federal government is 2.7 million, and the total cost of wages and salaries is roughly $400 billion.

The chart below shows that most federal government workers are in the US Postal Service, Veterans Affairs, Homeland Security, and the Army, Navy, Air Force, and Department of Defense.

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The first chart below shows that the FOMC continues to revise higher where they think the Fed funds rate will be by the end of 2026.

The second chart shows that the Fed continues to revise higher where they think the Fed funds rate will be in the long run.

The third chart shows that the market continues to revise higher where it thinks the Fed funds rate is going.

The entire purpose of the Fed in keeping interest rates higher for longer is to slow down consumer spending, capex spending, and corporate earnings so that inflation begins to move lower toward the Fed’s 2% inflation target. 

The bottom line is that interest rates staying higher for longer is the number one theme in markets as we enter 2025.

This has significant implications for asset allocation and portfolio construction because the most important variable in the finance textbook is the risk-free interest rate. When the risk-free rate goes up, it raises the bar for returns on equities, particularly in a situation where returns in equities have been driven entirely by a handful of tech stocks. In short, higher for longer has important implications for how investors should think about debt versus equity in 2025.

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