Implications:  Inflation came in as expected in February, with the Consumer Price Index rising 0.3% and the year-ago comparison holding steady at 2.4%. “Core” inflation, which strips out food and energy, rose a consensus-expected 0.2%, while the year-ago comparison remained at 2.5%.  Looking at the details, headline inflation was led by the volatile energy and food categories in February, with prices increasing 0.6% and 0.4%, respectively.  Housing rents (those for actual tenants as well as the imputed rental value of owner-occupied homes) was the main driver of core inflation for the month and has been over the last few years.  The good news is that the category finally appears to be turning over, with rents rising only 0.2% and up at a 2.4% annualized rate over the last six months, lagging core inflation.  Other notable increases in the core grouping include prices for medical care services (+0.6%), airline fare (+1.4%), and hotels (+1.1%).  Many analysts – including those at the Federal Reserve – warned of a renewed inflation surge from tariffs in 2025.   But if you’ve been reading our content over the past year, then you would have known to look past the tariffs and instead focus on the M2 measure of the money supply for understanding where inflation would go.  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 – and given the slow growth over the last 3+ years – we were not surprised to see inflation continue its bumpy path downward in 2025.  Now, both headline and core inflation sit at or near their lowest twelve-month pace since the great inflation scare began nearly five years ago.  While progress has been made, inflation still remains above the Federal Reserve’s 2.0% target, and the data do not yet capture the effects of surging oil prices following the outbreak of war with Iran on February 28th.  As a result, this report will not be enough to persuade Fed officials to resume rate cuts at the meetings next week.  Instead, the next rate cut will have to wait until at least June, when the Fed should have new leadership.

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Implications: Existing home sales rebounded modestly in February, following severe winter storms that held back activity in January.  That said, sales remain near the low seen following 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 good news is that affordability has been improving in several notable ways. First, 30-year mortgage rates have been trending lower since early 2025 and now sit around 6.1%, the lowest rate since 2022. Unfortunately, the outlook for interest rates going forward has become murkier recently, with the war on Iran raising energy costs and threatening to have an upward impact on inflation expectations.  Meanwhile, the median price of an existing home is up only 0.3% 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. The biggest headwind remains inventories, where growth continues although at a slower pace than last year. This has led to a months’ supply of homes (how long it would take to sell existing inventory at the current very slow sales pace) of 3.8 in February, well 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. Despite these cross currents, underlying fundamentals have improved recently, which should contribute to a modest upward trend in sales in 2026.

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About a month ago the financial markets were surprised by a January jobs report that was stronger than expected.  The consensus was for a gain of 68,000 private-sector jobs, but the actual came in at a much higher 172,000.  We noted the good news at the time but also said that we should “look for much slower headline numbers on payroll growth in the months ahead.”

And that’s exactly what we got in February, with private payrolls falling 86,000, well short of the consensus-expected gain of 60,000.

Some saw the February report as a sign of a potential recession, but we think that’s taking it much too far.  The past two months should be looked at together, not separately.  And together, including revisions, private payrolls rose 30,000 per month, in spite of a nurses’ strike and unusually bad weather in February that should reverse in March.  

Normally, private-sector job growth of 30,000 per month could be considered weak.  But with strict immigration enforcement and an aging native population, it is very close to the underlying trend.  In other words, nothing we’ve seen on the labor market tells us the economy is booming or in recession.  Look for very modest growth in jobs, on average, in the months ahead.  

Don’t get us wrong; we are not “worry-free” when it comes to the US economy.  The size of government expanded tremendously during COVID and has still not receded to pre-COVID levels.  Meanwhile, inflation remains stubbornly above the Federal Reserve’s 2.0% target.  Stocks are overvalued and the loss of wealth that would accompany a correction in stock prices or a bear market would be a headwind for economic growth in the short term.  

However, there are reasons to remain positive, as well.  Technological innovation continues and the use of AI is spreading, potentially boosting productivity growth (output per hour) and facilitating entrepreneurship from people who otherwise would not be able to bring their ideas to life because of a lack of programming skills.

Think about it for a second: Mark Zuckerberg was able to create Facebook because he had some interesting ideas paired with his very own computer skills.  But the next Zuckerberg doesn’t need those same computer skills, meaning more ideas can come to fruition and we all benefit from a more competitive economy.       

In the meantime, you are sure to hear concerns this week about oil prices, which have surged.  When you do, remember that although Americans will be paying more at the pump and elsewhere for energy, American energy producers will be earning more income and incentivized to expand production.  On net, this should not push us into recession.  

The economy expanded 2.2% in 2025 and looks like it’s starting out 2026 at about the same tepid pace.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications:  Overall retail sales declined in January as severe winter weather that swept across much of the country disrupted consumer activity during the month. Looking at the headline, the -0.2% decline was slightly better than the consensus estimate of -0.3%, with seven out of the thirteen major service industries moving lower in the month.  Looking at the details, the largest decline came from a 3.0% drop at health & personal care stores – the biggest decline for the category since the COVID lockdown. Falling sales at gasoline stations (-2.9%) and autos (-0.9%) also contributed.  The good news is that “core” sales, which strip out the volatile categories for autos, building materials, and gas stations – important for estimating GDP – rose 0.2% in January and was revised slightly higher in previous months.  The effects of cold weather were most evident among brick-and-mortar retailers; along with the drop at health care and personal stores, sales also fell sharply at clothing stores (-1.7%) and sporting goods stores (-1.2%).  Meanwhile, the category for restaurants & bars – the only glimpse we get at services in this report – slipped 0.2% in January, the third decline in the last four months.  These sales are up 3.9% in the last year (above the increase for overall sales) and will be worth watching in the months ahead as a bellwether for the consumer's overall well-being.  Another category we are closely monitoring is non-store retailers (think internet and mail-order), which naturally benefitted from consumers stuck at home during the month.  This category increased 1.9% in January and is up 10.9% in the past year, the highest of any major category.  Finally, it’s important to remember the impact inflation has on retail sales.  Overall sales have risen 3.2% in the past twelve months, but “real” inflation-adjusted sales were up only 0.7% during that timeframe and still below the peak in early 2022.  In other words, no growth in nearly four years. While some of the weakness in this month’s report may reverse in the months ahead, the broader trend remains soft.  In other recent news, import prices rose 0.2% in January while export prices rose 0.6%.  In the past year, import prices are down 0.1%, while export prices have risen 2.6%.

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Implications: The job market was weak in February but not a reason to panic.  Nonfarm payrolls fell 92,000 for the month, coming in well below consensus, and when including downward revisions to prior months the net decline was 161,000.  The private sector, which has been stronger than headline payrolls, posted a decline of 86,000 driven by leisure and hospitality, healthcare, and education. Meanwhile civilian employment, an alternative measure of jobs that includes small-business start-ups, also posted a decline of 185,000. But while the February report was undoubtedly soft, we don’t think it signals a recession.  First, a huge winter storm hit half the country last month.  Second, a nursing strike hit health care jobs, which declined 28,000 in February. Both of these factors should reverse next month. Third, now that we have revisions to jobs data, we know that private payrolls declined in four separate months last year even as real GDP rose 2.2% and avoided recession. In that context, today’s headline losses look a lot less worrying for the broader economy. Also, given the large gains in jobs in January, it makes more sense to look at today’s data in combination to cut through the volatility. That shows an average gain in private sector payrolls of 30,000 per month, by no means a booming economy, but probably consistent with slower trend growth following massive shifts in immigration policy that have significantly reduced labor supply. Given the data on Q4 productivity that was released yesterday showing an increase of 2.8% in the past year, real GDP can continue to grow even with the slowing labor market. Those productivity gains have also sustained healthy gains in pay, with average hourly earnings going up 0.4% in February and 3.8% in the past year.  That said, total hours worked remained unchanged in February and are up a weaker 0.6% in the past year.  As a result, total earnings rose 4.4% in the past year despite the broader weakening in the labor market. One last thing to keep in mind is that federal payrolls, excluding the Post Office and Census, are down 322,100 since the Trump Administration took office, the steepest drop in decades.  But even factoring that in suggests we should expect headline numbers on payroll growth to be slow in the months ahead. In other recent news, initial jobless claims remained unchanged last week at 213,000, while continuing claims rose 46,000 to 1.868 million.

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In this week’s “Three on Thursday,” we examine the current state of U.S. household indebtedness and financial health. Curious about the latest trends? Click the link below to get a clearer picture of where things stood in the fourth quarter.

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Implications:  The service sector had positive momentum in February, as the ISM Services index jumped to 56.1, beating even the most optimistic forecast from any economics group surveyed by Bloomberg. The February reading is the highest since July of 2022.  Looking at the details, fourteen out of the eighteen major service industries reported growth for the month, while three reported contraction, and one remained unchanged. The major measures of activity were mostly higher in February, with all standing above 50, signaling growth. The business activity index climbed for the fifth straight month to reach the highest level in almost two years at 59.9.  Meanwhile, the new orders index jumped to 58.6 from 53.1 in January, marking eleven out of the last twelve months the index has expanded. Survey comments point to a variety of headwinds and tailwinds facing service companies, which have been affected by unusually cold weather and the recent Supreme Court ruling on tariffs. However, even with the shake-up from the tariff ruling, uncertainty surrounding future trade policy is waning. Notably, a survey comment from the Agriculture industry wrote, “Our industry seems to have adapted to the tariffs. The costs are embedded into the import cost the company has to shoulder.” Given the stability, service companies have increased hiring for the third consecutive month, with the employment index rising to 51.8. However, breadth remains limited, as only seven industries reported an increase in employment versus five that reported a decline. The highest reading of any category was once again the prices index, which moved to 63.0.  Though the index remains elevated, it is still far from the worst we saw during the COVID supply-chain disruptions, when the index reached the low 80s.  We will continue to monitor the M2 money supply – which has grown very slowly over the last 3+ years – for whether these pressures turn inflationary.  In other news this morning, ADP’s measure of private payrolls increased 63,000 in February versus a consensus expected 50,000.  We’re estimating Friday’s official report will show a nonfarm payroll gain of 33,000 with the unemployment rate remaining steady at 4.3%. In other recent news, cars and light trucks were sold at a 15.8 million annual rate in February, up 6.1% from January and down 1.6% from a year ago.

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Implications: Activity in the manufacturing sector surprised to the upside for the second month in a row in February, while the price index signaled that inflation remains stubbornly high.  Although the ISM Manufacturing Index slipped to 52.4, this marks the first time the ISM Manufacturing Index has been in expansion territory for consecutive months since it briefly rose above 50 last January and February. While we remain cautious given last year’s head-fake, the recent strength is a welcome development for an industry that has faced an army of headwinds in recent years.  Looking at the details, growth broadened in February, with twelve out of the eighteen major manufacturing categories reporting growth (versus nine in January), while five reported contraction, and one reported no change.  The major measures of activity were mixed, as the categories for new orders and production retraced from January’s rapid pace, but remain in solid expansion territory at 55.8 and 53.5, respectively.  Notably, outside of January, this is the highest new orders reading in nearly four years.  It’s important to remember that order books were already weak heading into last year, and to keep production going, manufacturers had to rely on their order backlogs. The order backlog index was in contraction territory for thirty-nine consecutive months before moving into expansion territory last month, and the pace accelerated in February, with the index rising to 56.6. Despite signs of improving demand, it was not enough to meaningfully change hiring efforts.  The employment index rose to 48.8 in February – the highest level in a year – but remains below 50, signaling contraction, now for the 29th consecutive month.  The bad news in the report was a renewed pickup in pricing pressures, with the prices index jumping to 70.5 in February from 59.0 in January. With the recent Supreme Court ruling against much of the Trump’s Administration tariffs, along with the rise in oil prices following the U.S. and Israel strike on Iran, we expect volatility to continue for this category in the months ahead.  In other news this morning, construction spending rose 0.3% in December, as increases in homebuilding and power projects fully offset declines across most other categories.

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As we all know, the US and Israeli militaries attacked Iran.  The old Ayatollah and his successor are dead, along with much of the rest of Iran’s political and military leadership.  How should investors respond?

First, in overnight trading oil prices were up over 8%.  US stock price indices are also down. And in a flight to safety, 10-year Treasury bond yields fell under 4%.  When the US invaded Iraq in March 2003, the stock market rose sharply and nearly doubled between then and the peak in 2007.

But that stock market was undervalued after the dot.com crash of 2000-2003.  Today, the market is over-valued.  History may rhyme, but it doesn’t repeat.  War is uncertain, and while the US and Israel are dominating, investors would be foolish to assume they know every twist and turn to come.  Even here at home, where threats exist.

So we would like to turn our attention to what seems like a seismic shift in the direction of threats to Western Civilization.  Not long ago, during COVID, Klaus Schwab and the World Economic Forum published a book titled “COVID-19: The Great Reset.”  Politicians around the world, including Boris Johnson, Angela Merkel, Joe Biden, Kamala Harris, and others talked about “Building Back Better,” which was a euphemism for The Great Reset.  The platform included Green Energy and the Paris Agreement, Open Borders, Global Taxes, International Cooperation, and Sustainable Development.  While a generalization…it seems clear the supporters of Build Back Better wanted even more government spending and more bureaucratic control.

Over recent decades, bureaucracies (the EU, UN, NATO, WHO, the US administrative state) have all increased control over free markets because they believe capitalism hurts the environment and creates inequality.  Second, China, Russia, Iran, and North Korea have actively attempted to undermine the US and its capitalist system.  And third, cartels and gangs have proliferated, some fielding armies.

In other words, there are three sets of institutions or groups trying to reset the world and put roadblocks in the way of capitalism.  They want a Great Reset that gives them more power.

But the US, in its 250th year, seems to be reaching back to its roots.  The US is saying “no” to bureaucrats and corruption in international organizations, and “no” to terrorism and cartels who are willing to use violence (like the mafia) to get their way.  

Back in 1908, we founded the Bureau of Investigation (BOI), the precursor to the FBI, to fight corruption in government and then shifted to fighting gangsters and the mafia.  Similarly, recent actions are designed to fight the enemies of freedom today.  If there is a common theme running though the actions of the US in the past year, it is fighting back against the institutions, governments, and entities which want to undermine capitalism.  That would be a really Great Reset.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications: The key to producer prices is to watch the trend, not one-off volatile readings. Producer prices started 2026 by rising 0.5% in January, despite falling prices from the typically volatile food and energy categories.  But even with the outsized monthly reading, producer prices moderated on a year-ago basis and are up 2.9% versus January 2025.  A look at the details shows the jump in January itself was concentrated and unlikely to sustain in the months ahead. Over twenty percent of the increase came from a rise in margins for machinery and equipment wholesaling, which rose 14.4%. As a result, prices for the broader services category rose 0.8% in January and are up 3.4% in the past year.  Many likely assumed it would be goods prices that would be leading inflation higher, given the higher tariff rates implemented under President Trump, but goods prices declined 0.3% in January (this was before the Supreme Court ruling that moved tariff rates) and are up a modest 1.6% in the past year.  It must be noted the January goods reading was muted by the abovementioned declining prices for energy (-2.7%) and food (-1.5%).  “Core” producer prices – which excludes those typically volatile categories — rose 0.8% in January, tied for the largest month increase since mid-2022.  We don’t expect the wholesale margins that pushed January producer prices higher will continue in the months ahead.  Again, watch the trend, not one-off readings. Sustained movements in overall inflation are led by the money supply, which rose 0.3% in January, is up 4.3% in the past year (historically, M2 growth has averaged around 6% per year).  Volatility may continue month-to-month, but we expect this monetary tightness will keep inflation relatively subdued, leaving room for rate cuts to restart at some point later in 2026.  In other recent news, initial jobless claims rose 4,000 last week to 212,000, while continuing claims declined 31,000 to 1.833 million.  This is consistent with modest job growth in February.  On the housing front, the FHFA index rose 0.1% in December and is up 1.8% in the past year, while the national Case-Shiller index rose 0.4% in December and is up 1.3% from a year ago.  Expect only modest gains in home prices to continue given a deceleration in rents, which means potential homebuyers have less motivation to buy.  On the manufacturing front, the Richmond Fed index, a measure of mid-Atlantic factory activity, fell to -10 in February from -6 in January, while the Kansas City Fed Manufacturing Index rose to 5 in February from a reading of 0 in January. 

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