Implications:  After a hot start to 2025, both incomes and spending surprised to the downside in May.  Personal income declined 0.4%, lagging even the most pessimistic forecasts, while prior months data were revised lower as well.  However, the details show a better picture than the headline suggests.  Private-sector wages and salaries rose 0.4% in May, but were more than fully offset by a decline in government transfer payments related to social security, and a drop in farm income.  Both of those declines may sound concerning, but in reality May was simply a return back toward more “normal” levels following large one-time payments related to the Social Security Fairness Act – one of the last items signed into law by the outgoing Biden administration, which increased benefits to public sector workers not typically covered by Social Security – and the Emergency Commodity Assistance Program, which made payments to farmers producing certain commodities to help offset higher input costs and lower sale prices.  These were never reliable (or desirable) long-term sources of income like wages and salaries, so while incomes were lower in May than in April, the mix of where spending power came from improved.  What was more disappointing was the 0.1% decline in personal consumption, where spending on services rose 0.1% while goods spending declined 0.8%.  But even here the drop comes with a caveat.  Nearly the entire decline in goods spending came from a drop in motor vehicles and parts, a category where consumers picked up spending to front-run the tariffs and have since pulled back as tariffs went into place.  In addition, lower gasoline prices brought down outlays on energy goods. Within services, the largest increases came in housing & utilities as well as health care.  On the inflation front, PCE prices rose 0.1% in May while the twelve-month change increased to 2.3% from a 2.1% reading last month.  It is important to remember that inflation readings were very modest between May and November of 2024, so even modest monthly increases in inflation today may push year-to-year readings higher.  That does not mean that inflation is a rising threat, though we wouldn’t be surprised to see arguments from some for the Fed to hold rates steady until this subsides.  “Core” prices (which exclude food and energy) rose 0.2% in May and are up 2.7% versus a year ago. The Fed is unlikely to move at the July meeting, as it continues to fret about potential inflationary impacts from tariffs and continued uncertainty surrounding policy out of Washington, but we think the Fed will resume rate cuts in the later part of 2025.  In other recent news on the housing front, pending home sales, which are contracts on existing homes, rose 1.8% in May following a 6.3% decline in April, suggesting existing home sales (counted at closing) will dip slightly in June. On the manufacturing front, the Kansas City Fed Manufacturing Index, a measure of factory sentiment in that region, rose to a still weak reading of -2 in June from -3 in May.

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In this week’s “Three on Thursday,” we delve into the state of Social Security. Last week, the Social Security Trustees released their annual report, forecasting the program’s financial outlook over the next 75 years. The recent projections indicate that Social Security is only eight years from insolvency, necessitating urgent reforms.

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Implications:  New orders for durable goods soared in May at the fastest pace in more than a decade.  However, the16.4% increase in new orders was almost entirely due to the very volatile category of commercial aircraft, where orders more than tripled from April as President’s Trumps tour through Saudi Arabia, Qatar, and the United Arab Emirates was accompanied by a massive Boeing order from Qatar Airways. We anticipate airline orders to slow (and cancellations to increase) in the months ahead as companies and countries navigate the ever-shifting trade and economic environments.  But it wasn’t just transportations orders that rose in May, even excluding the transportation sector, orders for durable goods increased a healthy 0.5%.  The best news was that orders rose across the board, led by computers & electronic products (+1.5%), electrical equipment (+0.8%), and fabricated metal products (+0.7%), while machinery (+0.3%) and primary metals (+0.1%) rounded out the gains.  It must be noted the May gains are a bright spot on what has otherwise been a bumpy and modest path for ex-transportations orders, which have struggled to simply keep pace with inflation over the past year and have shown signs of slowing over recent months.  The most important number in today’s release, core shipments – a key input for business investment in the calculation of GDP – rose 0.5% in May.  If unchanged in June, these shipments would be up at a 3.3% annualized rate in Q2 versus the Q1 average.  The current environment in Washington – and geopolitical events abroad – remain uncertain, and we expect volatility in the data to be the rule rather than the exception for the foreseeable future.  In turn, the Federal Reserve must navigate what these changes mean for the path of inflation.  While we don’t currently expect any movement from the Fed at the next meeting in late July, we do believe that cuts are on the table starting in September, as economic weakness brings the employment side of the Fed’s mandate into more central focus.  In other news this morning, initial jobless claims declined 10,000 last week at 236,000, while continuing claims rose 37,000 to 1.974 million.  These figures are consistent with continued job growth in June, but at a slower pace than last year.

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Implications:   Hold off on GDP itself for a moment.  The most important part of this morning’s report was on economy-wide corporate profits, which declined 2.3% in the first quarter vs. the fourth quarter but are up 6.3% from a year ago.  Profits from domestic non-financial industries declined by 2.5%, while profits from domestic financial firms grew 2.3%. Profits from the rest of the world fell by 7.3% for the quarter.  Financial industry data include the Federal Reserve (either profits, or losses) and because the Fed pays private banks interest on reserves, and has raised interest rates, it has been generating unprecedented losses in recent quarters.  Excluding the losses at the Fed (because we want to accurately count profits in the private sector), overall corporate profits were down 2.7% in the first quarter but up 4.4% from a year ago.  However, plugging in non-Fed profits into our Capitalized Profits Model suggests stocks remain overvalued. Looking at the other details of today’s report, the final reading for real GDP growth in the fourth quarter was revised lower from last month’s estimate, coming in at a -0.5% annual rate, and the underlying components showed a weaker mix. Downward revisions in consumer spending (specifically services) and inventories easily offset a larger increase in net exports (imports grew slightly less while exports grew slightly more than originally estimated). For a more accurate measure of sustainable growth, we focus on "core" GDP, which includes consumer spending, business fixed investment, and home building, but excludes the more volatile categories like government purchases, inventories, and international trade. "Core" GDP grew at a 1.9% annual rate in Q4, lower than the prior estimate of 2.5% and the slowest pace in more than two years. Today we also got revisions to Q1 Real Gross Domestic Income (GDI), an alternative measure of economic activity.  Real GDI was revised higher to a 0.2% annual rate in Q1 and up 2.2% from a year ago.  GDP inflation was revised slightly higher to a 3.8% annual rate in Q1, and is up 2.6% over the past year, both still higher than the Fed’s 2.0% target.  Meanwhile, nominal GDP (real growth plus inflation) increased at a 3.2% annual rate in Q1 and is up 4.7% year-over-year.

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Implications:  New home sales disappointed in May, coming in weaker than any economics group surveyed by Bloomberg expected, and hitting a seven-month low. May’s decline of 13.7% was the largest since 2022 and happened on the heels of the largest gain since 2023 in April. Looking at the details, the South was responsible for the vast majority of today’s decline in sales. From a big picture perspective, buyers purchased 623,000 homes at an annual rate. However, while that pace may be well below the highs of the pandemic, sales today are roughly where they were pre-pandemic in 2019.  Though we expect a modest upward trend in sales in 2025, the housing market continues to face challenges. The biggest (and most obvious) is affordability. The Fed has recently paused their rate cuts, meaning the housing market is on its own for the time being with the average 30-yr fixed mortgage still hovering near 7%. Meanwhile, though median sales prices are down 7.3% from the peak in October 2022 they have been rising again recently and are up 3.0% in the past year.  The Census Bureau reports that from Q3 2022 to Q1 2025 (the most recent data available) the median square footage for new single-family homes built fell 5.6%. 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 may be 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 over 280% versus the bottom in 2022. This contrasts with the market for existing homes which continues to struggle with an inventory problem, often due to the difficulty of convincing current homeowners to give up the low fixed-rate mortgages they locked-in during the pandemic. While the future cost of financing remains a question, lower priced options and an abundance of inventories will help fuel new home sales in 2025.  In other recent housing news, home prices declined in April. Both the Case-Shiller and FHFA index fell 0.4% for the month but are up 2.7% and 3.1% respectively from a year ago. We also got new data on the M2 measure of the money supply, which rose 0.4% in May and is up 4.5% from a year ago.  This remains below the 6% growth that has been normal over the past few decades, and in combination with recent inflation reports, we think the Fed has room for modest rate cuts. Finally, on the manufacturing front, the Richmond Fed index, a measure of mid-Atlantic factory activity, increased to a still weak reading of -7 in June from a reading of -9 in May.

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Implications:  Existing home sales eked out a small gain in May, but remained sluggish after declines earlier this year. Sales activity has been characterized by fits and starts since 2022, with any positive upward trend eventually running into a ceiling of around 4.300 million.  Big picture, sales are still well below the roughly 5.250 million annual pace that existed pre-COVID, let alone the 6.500 million pace during COVID.  Affordability remains the biggest headwind, and unfortunately with the Federal Reserve still on pause with rate cuts, 30-year mortgage rates remain near 7%.  Meanwhile, the median price of an existing home is up 1.3% from a year ago.  Speaking of price, it looks like the housing market has bifurcated.  While overall sales are down 0.7% in the past year, homes worth $750,000 to $1,000,000 managed a small gain of 1.0% over that same period.  So, it looks like buyers and sellers in smaller segments at the higher end of the market have begun to adjust to the new reality of higher rates.  However, it also suggests that at the lower end of the price spectrum inflation has priced many Americans out of the existing home market.  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.  (When interest rates are higher, firms, including homebuilders, forego more potential earnings by holding onto inventories.)  Finally, many existing homeowners remain reluctant to sell due to a “mortgage lock-in” phenomenon, after buying or refinancing at much lower rates before 2022.  This remains an impediment to activity by limiting future existing sales (and inventories).  However, there are signs of progress with inventories rising 20.3% in the past year.  That has helped push the months’ supply of homes (how long it would take to sell existing inventory at the current very slow sales pace) to 4.6 in May, a considerable improvement versus the past few years, but still below the benchmark of 5.0 that the National Association of Realtors uses to denote a normal market.   A tight inventory of existing homes means that while the pace of sales looks like 2008, we aren’t seeing that translate to a big decline in prices.  Finally, the Philadelphia Fed Manufacturing Index, a measure of factory sentiment in that region, remained unchanged at a weak reading of -4.0 in June.

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Looking back on it, the first quarter of the year was a complete anomaly.  Real GDP declined at a 0.2% annual rate, and the left side of the political spectrum said this proved current policies were a disaster.

But industrial production expanded at a 4.5% annual rate in the very same quarter, the fastest growth rate for any quarter since 2021.  The quarterly decline in real GDP was a figment of tariff-induced front-running.  Excluding the surge in imports, economic activity continued to grow.

Now comes the first quarter’s mirror image.  The Atlanta Federal Reserve Bank’s GDPNow model is currently projecting that real GDP is growing at a 3.4% rate in Q2.  Believe it or not, that may be an underestimation.

The Atlanta Fed model assumes that the trade deficit in Q2 is smaller than in Q1 (back when consumers and businesses were “front-running” Liberation Day tariffs) but is still larger than it was in Q4 last year.  That’s possible, but we think the more likely outcome is that the Q2 trade deficit is smaller than in Q4 to make up for the surge in Q1.  And if we are right about that, real GDP could be up at a 5.0%+ annual rate in Q2.

Some people (on the right side of the political spectrum) are already calling this The Trump Boom.  Yet, as we said, it’s in the mirror, and guess what?  Data on industrial production are pointing in the opposite direction.  We are currently estimating that overall industrial production will be up at only about a 1.0% annual rate in Q2 and that manufacturing excluding autos will show growth of near zero.

Meanwhile, overall retail sales were 0.3% lower in May than at the end of last year, without factoring in higher prices.  If we factor in overall consumer price inflation, retail sales are down 1.2%.

In other words, the data are so choppy that discerning a true trend from the first six months of the year is virtually impossible.  Averaging the two quarters leaves us closer to trend growth.  But emerging weakness in many areas (outside of trade) means we are not out of the woods on recession risk.  To gauge underlying growth, we track “core” GDP—consumer spending, business investment, and homebuilding—excluding volatile swings from trade, inventories, and government. In Q2, core GDP looks to be growing near the slowest pace for any quarter since 2022.

Monetary policy has been tight enough to reduce the rate of inflation in the past couple of years, with the past four months especially slow.  The year-over-year changes to the CPI in the next few months are not likely to show additional improvement, because last year’s monthly data was weak.  Pay attention to three-month and six-month trends this year, not the year-over-year changes.

Chairman Powell is still selling the story that tariffs are inflationary, despite a lack of evidence.  The Fed will use the year-over-year CPI readings in the next few months to say they were right, this is why it is important to look at annualized rates for this year, not year-ago comparisons.

While the Federal Reserve may be wrong, it is still transparent.  So, because of the wrong-headed belief that tariffs cause inflation, there will likely be no cut in short-term rates until September.  But a monetary policy tight enough to slow inflation is certainly tight enough to slow the economy.  As this becomes evident, cuts will be forthcoming.

In the meantime, some investors are worried about the situation in the Middle East.  The way we look at it, actions taken by any country that make it less likely Iran develops nuclear weapons and mechanisms to deliver them are a good thing.

True, in the short term, Iran may threaten oil traffic in the Strait of Hormuz.  But many countries have an interest in being able to buy and sell oil using that passage, including Iran itself and its allies.  China, for example, would not like to see a major spike in oil prices.

The US, in spite of the drawdown in the strategic petroleum reserve, has much less to lose, even in the short-run.  If Iran tries to force oil prices higher, expect the rig count in the US to soar.

Our biggest concern would be a policy shift toward getting US “boots on the ground” in Iran, which could end up being very costly and require a political coalition of support on Capitol Hill that shifts legislative priorities away from extending the 2017 tax cuts and reducing government spending in the years ahead.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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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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