The Federal Reserve held rates steady today, while also projecting slow economic growth, higher unemployment, and higher inflation. And while the Fed signaled that two further rate cuts are still their base-case for the remainder of 2025, the timing of those cuts remains up in the air.

Starting with the survey of economic projections, the Fed’s view on the remainder of 2025 has weakened since the latest forecasts in March.  “Real” – inflation adjusted – growth for 2025 has been downgraded to 1.4% from the 1.7% anticipated back in March, while growth expectations for 2026 were reduced to 1.6% from 1.8%.  Other estimates moved higher, but not in the categories you would hope. Consistent with slower economic growth, the unemployment rate (currently at 4.2%) is now expected to rise to 4.5% by year-end and remain there through 2026, while prior forecasts anticipated the unemployment rate to hit 4.4% this year before declining next year.  Inflation expectations for this year likewise rose to 3.0% for PCE prices (the Fed’s preferred inflation metric) from a prior estimate of 2.7%, while next year is now anticipated at 2.4% versus a prior estimate of 2.2%.

With slower expected growth, and higher unemployment, the Fed continues to anticipate that two rate cuts will be appropriate before year-end, but tariff inflation concerns now have them anticipating that rate cuts will progress at a slower pace over the following two years. We believe that the Fed’s concern over higher and more persistent inflation related to tariffs is misguided.  Yes, tariffs can raise prices for the tariffed items, but they leave less money left over for other goods and services. They shuffle the deckchairs on the inflation ship, but don’t change how high or low the ship sits in the water.  That’s up to the money supply, which is barely higher today than it was in April 2022.  We believe this relative monetary tightness is why inflation has slowed recently, with CPI up at a 1.0% annualized rate in the last three months.    

Changes in today’s Fed statement were less dramatic.  Today’s statement included text that previously noted the unemployment rate had “stabilized at low levels” now simply stating that the unemployment rate “remains low.”  Meanwhile text around the level of uncertainty in the outlook softened to say uncertainty has “diminished but remains elevated”.  Along with that change, the Fed removed previous language that “risks of higher unemployment and higher inflation have risen.”  A bit odd, considering that they raised inflation and unemployment rate forecasts at the same time. 

The press conference brought little new information, with Powell reiterating that the economic environment justifies a continued pause while we wait and see the impacts from changes out of Washington.  Powell waived off concerns surrounding Middle East conflict and the threat of higher oil prices, but did acknowledge that the global landscapes are changing as immigration, trade, and geopolitics are in the spotlight. This – he rightly states – is the purview of Congress, not the Fed, but real change is happening in the world around us. 

We admit this is an incredibly difficult time to forecast, with soft sentiment data moving in a negative direction alongside weakness in some hard data such as housing, while many other measures of activity continue to progress.  How the economy will progress in the short term if true progress is made in cutting deficit spending and signing new trade deals is still to be seen. The era of easy everything is over, and while that may not be a welcome transition for many, it’s a necessary transition. 

Much could happen between now and the next Fed announcement scheduled for July 30th.  There will be two more readings on PCE inflation, another employment report, potential progress on the tax bill, and a whole lot of tweets. Throughout this period of increased uncertainty, we are working harder than ever to dive into the data and identify the trends that we believe are critical to navigating the current environment. From the Monday Morning Outlook, Three on Thursday, Data Watches, and Wesbury 101 videos, our goal is to help bring you clarity on the numbers that matter most.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications:  May was a tough month for homebuilders, as both housing starts and new permits fell to the slowest pace since the COVID shutdowns.  However, the details were not quite as bad as the headline.  First, the decline in starts in May was entirely due to a 29.7% drop in the volatile multi-family category, easily offsetting the 0.4% increase for single-family starts.  The other silver lining is that homebuilders continued focusing on completing projects in May, with completions increasing 5.4% to a 1.526 million annual rate.  That marks the eleventh month in the last twelve with completions running above a 1.5 million pace.  The same cannot be said for starts and permits, which have been stuck in low gear since the Federal Reserve began tightening monetary policy back in 2022, and hover around levels reminiscent of 2019.  Looking at the big picture, builders face a number of headwinds: high home prices and mortgage rates that are no longer being held artificially low, the largest completed single-family home inventory since 2009, restrictive government regulations, and relatively low unemployment which makes it hard to find workers. Now, builders must also contend with much tougher immigration enforcement and the uncertainty of new tariffs and how they’ll affect building costs. This weighs heavily on the NAHB Index (a measure of homebuilder sentiment) which fell to the lowest level since the end of 2022 in May at 32.  Keep in mind a reading below 50 signals a greater number of builders view conditions as poor versus good, now the fourteenth consecutive month that has been the case.  Meanwhile, the total number of homes under construction continues to fall, down 13.7% in the past year.  In the past, like in the early 1990s and mid-2000s, this type of decline was associated with a housing bust and falling home prices.  But this time really is different.  With the brief exception of COVID, the US has consistently started too few homes almost every year since 2007.  So, while multiple headwinds may hold back housing starts, a lack of supply is lifting home prices.  In some high-flying areas prices are moderating, but national average home prices will likely continue higher.  In other news this morning, initial jobless claims declined 5,000 last week at 245,000, while continuing claims fell 6,000 to 1.945 million.  These figures are consistent with continued job growth in June, but at a slower pace than last year.

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Implications:  Uncertainty surrounding trade policy has been making data on the US industrial sector murky, and May was no different. While industrial production declined by 0.2%, the underlying details of the report were more of a mixed bag. The biggest source of weakness in May came from a 2.9% decline in utilities output, which is volatile and dependent on weather. Meanwhile, the manufacturing sector (which is most directly impacted by trade and tariff policy) eked out a small gain of 0.1% in May.  Auto production jumped 4.9% in May on the heels of a 2.3% drop in April.  Given the global nature of auto industry supply chains, we expect ongoing trade negotiations to keep volatility in this sector high going forward.  The worst news in today’s report was that non-auto manufacturing (which we think of as a “core” version of industrial production) fell 0.3% in May, the second decline in a row. That said, there were some bright spots in this “core” measure.  Production in high-tech equipment rose 0.4% in May, likely the result of investment in AI as well as the reshoring of semiconductor production.  High-tech manufacturing is up 9.8% in the past year, the fastest pace of any major category.  The manufacturing of business equipment has also accelerated lately, rising 0.8% in May, and 17.7% at an annualized rate in the past six months. And this hasn’t just been driven by the high-tech equipment mentioned above. Transit and industrial equipment production have outpaced information processing equipment (think AI data centers), pointing towards a broader reindustrialization effort in the US. Finally, the mining sector increased 0.1% in May.  A faster pace of metal and mineral extraction more than offset a slowdown in the drilling of new wells. Oil and gas production was unchanged in May but is up 2.5% in past year. Look for an upward trend in activity in this sector in 2025 as the Trump Administration takes a more aggressive stance with permitting.

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Implications:  Retail sales came in below consensus expectations in May, posting the largest monthly decline since March 2023, while last month’s reading was revised down as well.  Part of recent weakness is payback for tariff front-running earlier this year.  For example, autos sales posted the largest decline of any category in May (-3.5%), but is still up 2.5% from a year ago.  The next biggest decliners were sales for building materials (-2.7%) and gas stations (-2.0%), both of which can be volatile month to month.  Strip out these three categories and you get “core” sales, which ticked up 0.1% in May.  These sales are up 5.0% in the past year but have been slowing in 2025: up at a 3.3% annualized rate through May (which includes the bump from tariff front-running).  This underscores the deeper issue at hand for the economy: monetary policy tight enough to bring inflation down is also tight enough to bring growth down.  One category we will be watching closely for this is at restaurants & bars – the only glimpse we get at services (which make up the bulk of consumer spending) in the retail sales report.  That category fell 0.9% in May, the largest decline since early 2023, although it is still up at a 10.1% annualized rate in the last 3 months, suggesting that consumers have shifted some of their spending to services while the dust settles around tariffs.  Looking at the big picture, retail sales are up 3.3% on a year-to-year basis and sit just below all-time highs.  However, “real” inflation-adjusted retail sales are up 0.9% in the past year and are still down from the peak in early 2021.  This highlights the ugly ramifications of inflation: consumers are paying higher prices today but taking home fewer goods than they were four years ago.  Going forward, we expect retail sales to remain choppy as consumers respond to the global trade reordering currently underway.  In other recent news, the Empire State Index, which measures manufacturing sentiment in the New York region, declined to -16.0 in June from -9.2 in May.  On the trade front, import prices were unchanged in May while export prices declined 0.9%.  In the past year, import prices are up 0.2% while export prices are up 1.7%.

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The United States consumes a large share of its GDP; China, not so much.  The result is Yin and Yang.  On net, China produces and the US consumes.

Treasury Secretary Scott Bessent put it this way last week at a Senate hearing – “China has a singular opportunity to stabilize its economy by shifting away from excess production towards greater consumption.”

That is the rallying cry for tariffs and trade negotiations.  And while the US government seems to blame it all on China, it is also true that the US has a “singular opportunity” to shift away from excess consumption toward greater production.

John Maynard Keynes convinced a troubled world that markets periodically fail and when it happens more government spending is the answer.  On the blackboard, Keynesian economics is pretty simple: Tax those with a high “marginal propensity to save” and give to those with a high “marginal propensity to consume.”  And since consumption is almost 70% of GDP, this transfer of wealth will lift growth.

In the real world, it doesn’t actually lift GDP, but it does lift consumption.  Since 2008, real consumer goods expenditures are up 62% in the United States.  Unfortunately, the most aggressive measure of US “value-added” manufacturing is only up 14%.  In other words, because of government policy, the US economy is off kilter.  We consume more than we produce…the exact opposite of China.

We don’t know whether China is intentionally taking advantage of the US, or whether US policies are just making it too easy, but blaming the full problem on China is not right.

The more the US redistributes and regulates industry, the more the US consumes and the less it produces.  The real fix is to cut government spending, cut tax rates, and reduce regulations.  But the President can’t do all these things without Congress.  The President can increase tariffs, which are taxes, but the Courts will eventually decide whether the methods he used to raise tariffs are legally acceptable.

In other words, we can blame China for consuming less and producing more, or we can look at the US and realize we consume more and produce less.

In a way, this issue resembles the debate around MAHA – the movement to Make America Healthy Again – and the simple point it’s trying to make.  The US has more obesity and diabetes than it should.  And the reason, according to MAHA, is that our food supply is lousy.  Right now, says MAHA, what we do is treat the symptoms created by our food complex, not the root cause.

Now think about tariffs.  We import more because we over-consume and under-produce.  Tariffs treat a symptom of bad government policies, but do not address the real problem.  And it’s not all China’s fault.

Don’t get us wrong: We are not asserting that China is playing fair; they aren’t.  They steal intellectual property, they pay workers less than they should, and they take advantage of the US’s consumer-driven society.  On top of that, they want to undermine US geo-political strength.

What we are saying, is that the US needs to stop subsidizing consumption and punishing production.  The US, for almost 100 years, has listened to Keynes and followed a Keynesian path.  Higher taxes, more spending, and too much regulation.  If we really want to fix this, we can’t just ask China to consume more and produce less.  The US must do the opposite.

In this world of “dueling economies” the US continues to shoot itself in the foot while trying to blame other countries.  It’s time to get our own house in order, regardless of what China does.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Real (inflation-adjusted) GDP shrank in the first quarter of 2025—marking the first contraction since 2022—and instantly igniting partisan crossfire. In this week’s Three on Thursday, we cut through the political noise and dissect the real drivers behind the Q1 slump and assess whether the weakness is likely to persist or reverse in Q2. 

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Implications:  While chatter about the threat of higher inflation from tariffs has echoed across the media, producer prices haven’t got the memo.  Following declines in March and April, producer prices rose a modest 0.1% in May.  Even the typically volatile food and energy categories had a quiet month in May, with food prices rising 0.1% and energy prices unchanged.  “Core” producer prices – which exclude food and energy – also rose 0.1% in May and are up 3.0% versus a year ago, with both goods and services showing prices slightly higher last month.  In a twist of irony, prices for goods, which would logically seem the area most exposed to higher import costs, rose 0.2% in May but are down at a 2.8% annualized rate over the last three months.  In May, rising costs for tobacco, poultry, and gasoline were partially offset by declining costs for jet fuel, pork, and carbon steel scrap.  Services, which represent a much larger share of the economy, saw prices rise 0.1% in May as final demand trade services (think margins received by wholesalers) increased 0.4%, while final demand transportation and warehousing services declined 0.2%.  The Federal Reserve meets next week to discuss the path forward for rates, and while we don’t anticipate a rate cut to be announced next Wednesday, they certainly have a lot to debate as their much-discussed concerns over a return of inflation pressures has proven once again that the Fed’s inflation models need some tweaking.  In other news this morning, initial jobless claims were unchanged last week at 248,000, while continuing claims rose 54,000 to 1.956 million.  These figures are consistent with continued job growth in June, but at a slower pace than last year.

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Implications:   While the Federal Reserve and many other analysts remain focused on tariffs, inflation came in below expectations for the fourth month in a row in May, rising only 0.1%.  Like we’ve been saying for some time, the link between tariffs and inflation is overrated. Yes, tariffs can raise prices for the tariffed items, but they leave less money left over for other goods and services. They shuffle the deckchairs on the inflation ship, not how high or low the ship sits in the water.  That’s up to the money supply, which has been essentially flat since April 2022.  We believe this relative monetary tightness is why inflation has slowed recently, up at a 1.0% annualized rate in the last three months.  Diving into the details, food prices rose 0.3% in May while energy prices declined 1.0%, driven by a 2.6% drop in gasoline prices.  “Core” prices, which strip out food and energy, rose 0.1% in May versus a consensus expected +0.3%.  Although core inflation has been much harder to subdue than overall inflation and is still up 2.8% in the last twelve-months, it has finally started following suit, up 1.7% annualized in the last three months.  Notably, prices continue to fall in categories many expected to be impacted by tariffs, including apparel (-0.4) and new vehicles (-0.3%).  We also like to follow “Supercore” inflation – a subset category of prices that excludes food, energy, other goods, and housing rents.  Fed Chair Jerome Powell said back in 2022 that they follow this category closely, though he stopped mentioning it when this measure stopped showing progress versus inflation. However, it appears the tide has finally turned for the category, with supercore prices up at just a 0.1% annualized pace in the last three months, while the year-ago comparison has fallen from 4.1% in January to 2.8% in May. That’s so much progress Powell might mention it next week at his press conference! Notable decliners this month within the supercore category were prices for airline fare (-2.7%) and hotels (-0.1%).  Although inflation is still above the Fed’s 2.0% target, given the lags in monetary policy and slow growth in the M2 measure of the money supply, we believe it’s time for the Fed to consider reducing short-term rates slightly in the months ahead.

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Back during the Financial Panic of 2008, clickbait media kept screaming “Hyperinflation.”  We consistently pushed back against this theme, and argued inflation would not accelerate.  Yes, Quantitative Easing and zero percent interest rates, which Ben Bernanke invented at the time, massively increased the size of the Fed’s balance sheet and boosted cash deposits and reserves at banks as the Fed printed money to buy debt – Treasury bonds, mortgages and other assets.

So why didn’t the QE of 2008-2015 cause inflation?  Because mark-to-market accounting destroyed capital faster than the Fed or Treasury (remember TARP) could boost it.  At the same time, regulators significantly lifted both the capital and liquidity ratios banks were required to hold.  The result: M2 grew at an average rate of 6% per year during the crisis, about the same rate as it did before.

This all changed during COVID. The Fed reduced liquidity rules and the Treasury enlisted banks in issuing direct tax rebates, making PPP loans, and distributing unemployment benefits, which caused M2 to surge.  It was one of the easiest forecasts we have ever made.  When M2 surges, so does inflation.  The CPI consumer price inflation peaked at 9.0% in mid-2022, the highest in roughly forty years.

The surge in M2 stopped in 2022.  Today, M2 is only 0.5% above 2022 peak levels.  Yes, M2 growth has picked up in the past year, but it is still growing relatively slowly, up 4.4% from a year ago, although up at 6.5% annual rate in the past three months.

In the meantime, “real” (inflation-adjusted) short-term rates have been hovering about 2.0% for the past two years the highest, for the longest, since 2006-07. 

It is because of this relative tightness in monetary policy that inflation has slowed, as well.  The annual increase in the CPI has slowed to 2.3% as of April.  Core inflation, which excludes food and energy and which peaked at 6.6%, is now down to a more respectable 2.8%.   There’s a similar story for “Super Core” inflation which also excludes other goods as well as housing rents.

In the past three months, the CPI is up at only a 1.6% annual rate while producer prices are down at a 1.2% rate.   

This week we get updates on consumer and producer prices and, as the table below shows, we expect the reports to show inflation ran a little hotter in May than the three prior months, but not really hot in an absolute sense.  

This strikes many observers and investors as odd, because the Trump Administration’s tariffs have been in effect, although erratic, and should have been having an impact by now.  How can we have lower inflation and higher tariffs at the same time?  

Because, as we’ve been saying all along, the link between tariffs and inflation is overrated.  Yes, the specific items that are tariffed might rise in price, but that means less money left over to buy other goods and services, which reduces those prices.  Tariffs shuffle the deckchairs on the inflation ship, not how high or low the ship sits in the water.  That’s up to the money supply.

None of this suggests the Fed won’t reverse course and fully let down its guard.  In spite of all the progress, we are still above the Fed’s 2.0% inflation target.  Inflation may look gone, but boosting M2 and cutting interest rates sharply could reignite the embers of inflation which are still buried under the ashes from the COVID monetary fire.    

We think the economy overall is ready for a modest cut in rates.  In fact, all interest rates across the yield curve are finally above inflation.  We do not think the interest rate policies of the Fed were appropriate.  Neither the 2008 Panic or COVID were caused by monetary policy, so holding interest rates below inflation never made sense to us.  And, at this point, with the real federal funds rate at 2% there is room for roughly two 25 basis point cuts.  But the Fed is wrongly focused on tariffs, so while rate cuts now are warranted, the Fed is likely on hold until September.

Brian S. Wesbury, Chief Economist 
Robert Stein, Deputy Chief Economist

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Implications:  The headline payroll number beat consensus expectations slightly, but the totality of today’s report on the labor market shows a mixed bag.  Nonfarm payrolls grew 139,000 in May versus a consensus expected 126,000.  However, payrolls were revised down an unusually large 95,000 for the prior two months, leaving the net gain, including revisions, at a tepid 44,000. We like to follow payrolls excluding three sectors: government, education & health services, and leisure & hospitality, all of which are heavily influenced by government spending and regulation (that includes COVID lockdowns and re-openings for leisure & hospitality).  This measure of “core payrolls” increased only 5,000 in May and is up only a grand total of 26,000 in the past three months.  Meanwhile, civilian employment, an alternative measure of jobs that includes small-business start-ups (but is volatile on a month-to-month basis) dropped 696,000 in May.  Given that decline, why did the unemployment rate remain unchanged at 4.2%?  Because the labor force (people who are either working or looking for work), fell 625,000.  In the past four months the labor force is down 234,000, but with the native-born labor force up while the foreign-born labor force is down, a potential sign of the new Administration’s efforts against illegal immigrants.  Another sign of the new Administration is that excluding postal workers and census-related jobs, federal payrolls declined by 16,000 in May, the largest drop for any month in the past twenty years.  Compared to January, this measure of federal jobs is down 47,000, the largest four-month drop since the 1990s.   Long-term, reducing the size of government should help create more jobs in the private sector.  The best news for workers in May was that average hourly earnings rose 0.4% and are up 3.9% from a year ago.  Unfortunately, this may help the Federal Reserve justify postponing any rate cuts until later this year.  In the meantime, the share of unemployed workers who voluntarily left (or “quit”) their prior job dropped to 9.8% in May, the lowest level in four years and much lower than the 13.2% that prevailed in January.  The greater reluctance to leave a job without another job lined up suggests more anxiety on the part of workers about the near-term future.  We think that anxiety is warranted in spite of what is likely to be a strong second quarter for real GDP growth.  The (slight) fall of output in the first quarter and then the surge in Q2 is due to tariff policy, not a real bust-boom cycle.

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