In this week’s edition of “Three on Thursday,” we take a deeper look at the unemployment rate in the U.S., how it’s calculated, and why it matters. Every month, usually on the first Friday, the Bureau of Labor Statistics reports jobs data coming from two surveys of establishments and households. Today we will be focusing solely on the Household survey. To find out more, click the link below.

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Implications:  Despite higher inflation consumer spending remained strong in April.  Retail sales rose 0.5% for the month, matching consensus expectations, and were revised higher for prior months.  Yes, the gain in April was fueled by another large jump at gasoline stations (+2.8%) as national gas prices moved to their highest level since 2022.  However, gains were broad-based with nine out of thirteen major sales categories rising for the month.  The largest exception was in the autos category, which slipped 0.4% in April. We like to follow “core” sales, which strip out the volatile categories for autos, building materials, and gas stations and is important for estimating GDP.  This measure rose 0.5% in April and were up 0.8% when including revisions to earlier months. The largest increase in the core grouping once again came from nonstore retailers (think internet and mail-order) which rose 1.1% in April, the third gain above 1.0% in the past four months.  Sales in this category are up 11.1% in the past year, among the highest of any core category. Sales at clothing stores and furniture stores were the lone core categories to decline in April, falling 1.5% and 2.0%, respectively. Meanwhile, the category for restaurants & bars – the only glimpse we get at services in this report – rose 0.6% in April but are up only 2.7% in the last year, lagging overall sales.  Nominal retail sales have risen 4.9% in the past year, but it’s important to remember the impact inflation has on these figures.  “Real” inflation-adjusted sales are up just 1.1% in the past twelve months and still down from their peak in April 2022.  No growth in four years.  So despite the solid report in April, the broader picture remains soft.  Keep in mind that higher than normal tax refunds may be temporarily boosting the spending power of consumers, too.  In the meantime, expect continued volatility in this report as the war with Iran evolves.  In employment news this morning, initial jobless claims rose 12,000 last week to 211,000; continuing claims increased 24,000 to 1.782 million. In other news, import prices jumped 1.9% in April while export prices surged 3.3%, both the highest monthly increases since 2022.  In the past year, import prices are up 4.2%, while export prices have risen 8.8%.

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Implications: The producer price index rose at the fastest pace in more than four years as the ongoing conflict in the Middle East pushed energy prices higher in April. But inflation pressures proved more broad based than just oil.  While energy prices jumped 7.8% led by a 15.6% surge in the cost of gasoline, and food prices rose a more modest 0.2%, producer prices excluding these two typically volatile categories rose 1.0%, also the largest move since early 2022.  In fact, more than half of the April increase in producer prices came from services, which rose 1.2% led by final demand trade services, which measures the margins received by wholesalers and retailers.  Transportation and warehousing services – which are impacted by higher fuel costs which companies are passing along to customers – also showed a notable rise in April.  On the goods side, energy represented more than three-quarters of the 2.0% monthly jump in prices.  Further back in the supply chain, prices for unprocessed and processed intermediate goods rose 4.1% and 2.7% respectively.  Here price pressures were overwhelmingly led by energy processing.  If the Iran conflict ends sooner rather than later – and if that brings a return toward oil prices where they were back in February – inflation pressures should ease in the later parts of 2026.  Until then, incoming Fed Chair Kevin Warsh and the FOMC are unlikely to do anything with rates.  Instead, his early days are likely to be distracted by how to handle current Chair Jerome Powell (his term as chairman ends this Friday) who announced that he will remain on the Fed Board of Governors, which means he will retain a seat as a voting member on the FOMC.  That leaves Warsh as a chairman in name only, and any plans to shrink the size of the Fed’s balance sheet will be on the back burner.  We expect volatility and uncertainty to continue in the months ahead as the ongoing conflict in Iran puts pressure on oil prices and disrupts global supply chains. However, sustained movements in overall inflation are led by the money supply, which is up 4.6% in the past year versus the 6% trend prior to COVID when inflation remained low. We expect this monetary tightness will eventually bring inflation down, leaving room for rate cuts to restart at some point once the conflict in the Middle East dies down.

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Implications:  The conflict in the Middle East is still temporarily boosting measured inflation.  Price increases once again came in very high but as expected in April, with the Consumer Price Index rising 0.6% following a 0.9% increase in March.  The “core” CPI, which excludes food and energy, rose 0.4% on April, above the consensus expected +0.3%.  The difference between headline and core inflation came from energy, with prices rising sharply (+3.8%) for the second month in a row after the outbreak of war in Iran sent global oil prices sharply higher.  Energy prices accounted for 40% of the overall monthly increase, which pushed the year-ago comparison for headline inflation to a three-year high of 3.8%.  While we expect the effects of higher energy costs to reverse once the conflict winds down, the timing remains uncertain, leaving the Federal Reserve with little conviction in the near term for monetary policy.  In the meantime, core prices are up 2.8% from a year ago, higher than the 2.6% reading from a month ago, and still well above the Fed’s 2.0% target.  Housing rents (those for actual tenants as well as the imputed rental value of owner-occupied homes) were the main driver of core inflation for the month and have been for the last few years.  Recent data had hinted that rents might be finally starting to turn over, but April told a different story, with rents posting the biggest increase in more than two years (+0.5%), though much of the increase likely reflected a one-off adjustment by the BLS to correct for distortions caused by the government shutdown last fall.  Other notable movers in the core group include rising prices for hotels and airline fare (both +2.8%), as well as apparel (+0.6%), and falling prices for new vehicles (-0.2%) and health insurance (-0.4%).  Outgoing Fed Chair Jerome Powell at one point highlighted “Supercore” inflation – a subset category of prices that excludes food, energy, other goods, and housing rents.  That measure rose 0.5% in April, pushing the twelve-month comparison to 3.3%, an eight-month high.  The worst part of the report was that wages continue to lose ground to inflation, as “real” inflation-adjusted hourly earnings declined 0.5% and are now down 0.3% in the past year.  With the inflation picture highly uncertain in the near term, do not expect a rate change at Warsh’s first meeting as Fed Chair in June.  We in the meantime will be focused on developments in the M2 money supply, which we believe is the most reliable tool for forecasting sustained inflation and which suggest that once the Iran War is resolved, inflation may drop faster than most investors expect.

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Implications: Existing home sales continued to struggle in April, eking out a small gain but remaining near the lows of the past several years.  Looking at the big picture, sales remain at roughly the same pace as in the aftermath of the Great Financial Crisis and are well below the roughly 5.250 million annual pace pre-COVID (let alone the 6.500 million pace during COVID).  The main issue remains affordability which has taken a turn for the worse recently due to the war on Iran raising energy costs and having an upward impact on inflation.  The result has been a rapid increase in 30-year mortgage rates, which now sit around 6.4%. Higher inflation also takes further rate cuts from the Federal Reserve off the table for at least the near future. Buyers also face an ongoing headwind from tight inventories; the months’ supply of homes (how long it would take to sell existing inventory at the current very slow sales pace) was 4.4 in April, below the benchmark of 5.0 that the National Association of Realtors uses to denote a normal market.  Many existing homeowners also remain reluctant to sell due to a “mortgage lock-in” phenomenon, after buying or refinancing at much lower rates before 2022.  This means potential buyers will have to continue to deal with limited options.  Existing home sales also face significant competition from new homes, where in many cases developers are buying down mortgage rates to compete and move inventory. One piece of good news is that the median price of an existing home is up only 0.9% versus a year ago. Aggregate wage growth (hourly earnings plus hours worked) has been consistently outpacing median home price gains over the past year for the first time since 2023, which improves affordability. Considering these cross currents, and the fact that existing home sales have been stuck in low gear since the end of the COVID pandemic, we expect 2026 to likely be more of the same.

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The stock market is on an absolute tear, with the Nasdaq up 5% last week and nearly 13% year-to-date.  The proximate causes include a cease-fire somewhat holding with Iran, a 28% surge in S&P 500 corporate profits in the first quarter, and some consensus-beating economic reports, like Friday’s payroll numbers.

We have been cautious on this market…and overly pessimistic up to this point.  So, should we rethink that? Should we become more optimistic about stocks?

The optimistic case was summed up in an X post by James E. Thorne at Wellington Altus who said there is a “systematic underestimation of an AI-driven productivity revolution…a Cap Ex Super Cycle, [an administration that is] letting the economy run hot, and multiple expansion [due to] a Peace Dividend.  History suggests that when productivity waves coincide with supply-side policy and geopolitical de-escalation, as in the 1990s, both earnings and multiples expand beyond historical norms.”

Let’s go through this list one item at a time.  1) Is AI really driving a productivity boom?  According to McKinsey, 88% of companies say they use AI in at least one business function, but just 7% say they have expanded its use enterprise wide.  As far as we know, there are little data showing a direct correlation between AI and profitability.  While many could surmise this, it remains a forecast.  And, while, capex is growing, it is concentrated in (or related to) data centers.  Excluding that, investment is weak.  A Super Cycle is an exaggeration.

Events in the Middle East are certainly promising.  Having the UAE exit OPEC is a big deal.  It suggests a more “go it your own way” free market world, not one divided into factions.  However, Iran seems a long way from being willing to accept this reality and we are not convinced a “peace dividend” is really in the cards.  We hope and pray that it is, but we haven’t seen a Peace Dividend or full-blown geopolitical de-escalation yet, just hope.

Finally, are we really in a Supply Side revolution?  Well, Reagan cut the top income tax rate from 70% to 28%.  Other than tax cuts for tips, social security, and overtime, the top tax rate is the same today as it was last year, and will be next year.  Overall government spending has been flat, which means it is declining as a share of GDP, but Congress has yet to pass a budget that promises continued spending restraint in the future.

Regulation has been reduced, but could be expanded again if a more pro-regulation president gets elected in 2028.  Virginia is a perfect example…the new governor is trying to reverse the direction of policy put in place under the previous governor.  Recent spending and regulatory restraint don’t pre-commit future presidents and congresses to the same policies.

So, while many positive developments are taking place, the idea that we are entering into a long-term secular bull market seems a stretch.  The PE ratio on trailing earnings of the S&P 500 is currently near 29.  When Reagan entered office and cut both tax rates and spending, and broke the back of inflation, the PE ratio was 8.  Even if policies today were equally as good, the same kind of boom should not be expected.

We aren’t pessimistic even though it might sound that way.  The US (as it has done for 250 years) is pushing back against feudalism in all its forms.  At the same time, AI is a transformative technology.  But it will take time for these things to fully play out, and we think markets are underestimating the time, energy, and volatility it will take.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications: Solid labor market, but not without some blemishes.  Nonfarm payrolls rose 115,000 in April and 99,000 including downward revisions for prior months – either way beating the consensus expected 65,000.  Meanwhile, the unemployment rate remained at a relatively low 4.3%.  The job gains in April itself were led by health care & social assistance, transportation & warehousing, and retail.  Total hours worked in the private sector rose 0.3%.  We like to follow payrolls excluding government and health care & education (which are often driven by government policies), which rose 77,000 in April.  Notably, federal payrolls were down 9,000 in April.  Compared to January 2025, federal payrolls excluding the Post Office and Census are down 337,000, or 14%.  Leaving out the end of the Census every decade, the decline in federal payrolls in the past fifteen months has been the steepest since the wind-down from World War II. Over time, we think a smaller federal government will help boost growth in the private sector.  However, not all the details were as robust as the headlines.  For example, although they rose in April, payrolls excluding government and health care & education are down 107,000 from a year ago.  Civilian employment, an alternative measure of jobs that includes small-business start-ups, dropped 226,000 in April.  That series can be volatile month-to-month but is worth watching.  Yes, the unemployment rate was steady, but that was due to a 92,000 decline in the labor force (people working or looking for work), which ticked the participation rate down to 61.8%, the lowest since 2021.  Average hourly earnings rose a tepid 0.2% in April, which is very likely below the pace of inflation for the month.  Put it all together and we expect continued jobs gains in the months ahead but at a noticeably slower pace than the headline 115,000 for April.  In other recent news, initial jobless claims rose 10,000 last week to a still-low 200,000; continuing claims declined 10,000 to 1.766 million, also low.  Construction increased 0.6% in March after a 0.2% dip in February, with the net gain for those two months led by single-family home building.  Productivity (output per hour) increased at a 0.8% annual rate in Q1 and is up 2.9% from a year ago, a good sign versus the long-term trend of about 1.5%.  Unit labor costs increased at a 2.3% rate in Q1 but are up a mild 1.2% in the past year.  

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In Fiscal Year 2025, a staggering 69% of federal spending was allocated to payments to individuals, near the highest share ever recorded. In this week’s “Three on Thursday” we look at the composition and evolution of federal spending over history, and how the Federal Government has become not much more than the world’s largest money transferring machine. For deeper insights, click the link below.

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Implications: We got another double dose of data on new home sales this morning, and it looks like activity has bounced back sharply since January when severe winter weather caused the largest monthly decline since 2013. Sales rose 8.9% and 7.4% in February and March, respectively, and now sit at a 682,000 annual rate.  However, the overall trend in sales remains around pre-pandemic levels, which has been a ceiling of sorts for activity the past couple of years.  Unfortunately, the Iran War and its expected impact on energy prices and inflation have introduced new challenges. First, financing costs have recently spiked in response, with the average 30-yr fixed mortgage rate up roughly 30 basis points since the start of the conflict.  Second, despite a new Chairman at the Federal Reserve, further rate cuts are likely on hold for the time being. But while buyers are unlikely to get much help from interest rates, the good news is that prices have been trending lower for new builds in the past several years. Median sales prices are down 16% from the peak in October 2022.  The Census Bureau reports that from Q3 2022 to Q4 2025 (the most recent data available) the median square footage for new single-family homes built fell 9.7%. So, while part of the drop in median prices is due to smaller/lower-cost homes, there has also been a drop in the price per square foot.  This is partially the result of developers offering incentives to buyers in order to move inventory. Supply has also put more downward pressure on median prices for new homes than existing homes.  The supply of completed single-family homes is up 300% versus the bottom in 2022 and is currently at the highest level since 2009. This contrasts with the market for existing homes, which continues to struggle with convincing current homeowners to give up the low fixed-rate mortgages they locked-in during the pandemic to list their homes. While financing costs remain a headwind, less expensive options and an abundance of inventories may give home sales a modest boost in 2026.

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Implications:  Activity in the service sector expanded once again in April, although at a slightly slower pace than in recent months, as the ISM Services Index declined to 53.6 from 54.0. The slowdown was largely due to a retreat in new orders as elevated input prices stemming from the conflict in Iran have encouraged service companies to suspend purchases until stability returns.  Looking at the details, growth broadened in April with fourteen out of the eighteen major service industries reporting growth (compared to thirteen in March), while three reported contraction and one remained unchanged. The major measures of activity were mostly higher. The business activity index rose to 55.9 from 53.9, while the new orders index retreated to 53.5 after climbing to its highest level in more than three years in March.  That said, both the business activity index and the new orders index have shown expansion in at least eleven out of the last twelve months. Although growth continues at a solid pace, survey comments reveal caution surrounding higher input costs being passed through to service companies.  As a result, companies which began to increase hiring efforts at the start of the year have since brought hiring efforts to a standstill. After starting the year in expansion, the employment index fell to 45.2 in March, but rose in April to 48.0 – still contractionary, but at a more modest pace.  Unfortunately, the highest reading of any index was once again the prices index, which remained at 70.7 in April, matching the highest level since October 2022. Though the index remains elevated, it is still well below the worst we saw during the COVID supply-chain disruptions, when the index reached the low 80s. While the ongoing war in Iran is expected to affect input prices in the short-term, we will continue to monitor the M2 money supply – which has grown slowly over the last 3+ years – for whether these signals turn into long-term inflationary pressure.

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