If you expect Kevin Warsh to quickly take the helm at the Fed and start cutting rates, you need to adjust your expectations.

For one thing, the timing for Warsh getting confirmed as the new Chairman at the Federal Reserve is murky, at best.  The Senate hearing for Warsh has been delayed and yet to be rescheduled.  One issue is that retiring North Carolina Republican Senator Tom Tillis has said he will refuse to vote for Warsh unless and until the Trump Administration makes it clear it will not try to prosecute current Chairman Jerome Powell, for alleged cost overruns on Fed-related construction projects or otherwise.

Another reason why rate cuts are on the backburner is that even if Warsh gets confirmed in time for the June meeting he may not have the votes for rate cuts from other board members and Fed bank presidents.  The consumer price index jumped 0.9% in March on the back of soaring gas prices due to the Iran War.  These prices are now up 3.3% from a year ago, well above the Fed’s 2.0% target.

Yes, core consumer prices, which exclude food and energy,  were up only 0.2% in March – but they are still up 2.6% from a year ago.  Even Powell’s COVID-era invention of “SuperCore” inflation, which excludes not only food and energy but also other goods and rent, so that it focuses narrowly on services is up 3.1% on a year-ago comparison basis.  In other words, no matter how it’s viewed, inflation remains uncomfortably high.

Hopefully the Iran War will end soon and on favorable terms, which could quickly send oil prices back down to February levels.  And if it does then that may give enough Fed officials the confidence for some modest rate cuts.

But the end of the Iran War and its economic implications don’t seem imminent.  As we write this it appears that President Trump is willing to double-down on a closure of the Strait of Hormuz, which in the near-term means higher oil prices, less revenue flow for the Iranian government, and less access to oil globally.  It’s tough to read Trump’s mind, but we are guessing that he thinks a closure would get more NATO members, many of whom are dependent on Middle East oil, more involved and supportive of the US effort.

There are also reports that both Israel and Saudi Arabia (and perhaps others) are fully committed to regime change in Tehran, seeing this as the best opportunity to bring that about and if it doesn’t happen soon – via either a popular revolt or a coup – it might not happen for many years.

In the past, military conflict has not necessarily been bad for stocks.  Think 2003, when stocks did very well the same year that Gulf War II began under President George W. Bush.  But back then stocks were undervalued after getting crushed the prior three years, with the S&P 500 down more than 40% from the high in March 2000.    

By contrast, we believe stocks are still overvalued in spite of robust profit growth in the fourth quarter.  Unless profits soar from current levels or, in the alternative, we get much lower long-term interest rates without a recession, it’s going to be hard for US equities to generate the robust returns of the last couple of years.  We continue to urge investors to be cautious.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications:  Inflation came in very high but as expected in March, with the Consumer Price Index rising 0.9%. The “core” CPI, which excludes food and energy, rose 0.2% on March, slightly less than the consensus expected 0.3%.  The difference between headline and core inflation came from energy, as gasoline prices jumped 21.2% in response to a sharp increase in oil prices following the outbreak of war in Iran.  Gasoline prices accounted for nearly three quarters of the overall monthly increase, which pushed the year-ago comparison for headline inflation to a two-year high of 3.3%.  While we expect the effects of higher energy costs to reverse once oil prices normalize, the timing remains uncertain, leaving the Fed with little conviction in the near term for monetary policy.  In the meantime, core prices are up 2.6% from a year ago, still 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 over the last few years.  The good news is there have been some signs of rents finally turning over, with rents rising 0.3% in March and up at a 2.6% annualized rate over the last six months.  Other notable movers in the core grouping include rising prices for airline fare (+2.7%) and apparel (+1.0%) and falling prices for prescription drugs (-1.5%), health insurance (-1.4%), and used cars (-0.4%).  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 0.2% in March but remains up 3.1% from a year ago.  The worst part of the report was that wages did not keep pace with the inflation surge in March, as “real” inflation-adjusted hourly earnings declined 0.6% and have risen only 0.3% over the past year.  With the inflation picture highly uncertain in the near term, there is very little chance of a rate change at what could be Powell’s final meeting as Fed Chair in May.  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.

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With the first quarter of 2026 coming to a close last week, this week’s edition of “Three on Thursday” looks at the S&P 500 Index (the “Index”) over that period. As of yesterday’s close, the Index is down 2.2% on a total return basis since hitting its all-time high on January 27 of this year. Market breadth has shown signs of improvement. For a fuller picture of the events that unfolded in the first quarter, click on the link below.

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Implications: Incomes fell and spending rose in February, while inflation remained on everyone’s radar.  The decline in income was a surprise, but not as unpleasant as the headline suggests.  The drop was due to a 0.4% decline in government transfer payments, particularly smaller subsidy payments under the Affordable Care Act.  Our view is that over time less government spending will help boost the private sector.  In February itself, private-sector wages and salaries rose 0.2% and are up 4.6% in the past year.  However, government transfers are still up 6.0% from a year ago, which shows more work needs to be done on controlling government spending.  Meanwhile, personal consumption rose 0.5% in February, with a 0.9% jump in spending on goods while services spending rose 0.3%.  In the past year, spending on services is up 6.4%, compared to a 3.0% increase for goods.  The combination of stronger spending and weaker incomes left the savings rate at 4.0% – abysmally low. At the same time, inflation remains uncomfortably high with PCE prices – the Fed’s preferred inflation metric – up 0.4% in February, while the year-ago reading stands at 2.8%, matching where it stood in January, and virtually unchanged from the 2.7% reading for the twelve-months ending in February 2025.  “Core” prices, which strip out the volatile food and energy categories, also rose 0.4% in February, with the year-ago comparison remaining at 3.0%, exactly matching the pace seen for the twelve-months ending in February 2025.  Accounting for inflation, real consumption rose a modest 0.1% in February after a flat reading in January (and incomes fell). Expect volatility in the inflation readings in the months ahead as the geopolitical events in Iran, which escalated in March, start showing in the data.  In other news this morning, initial jobless claims rose 16,000 last week to 219,000, while continuing claims fell 38,000 to 1.794 million, suggesting jobs growth continues, but at a modest pace.

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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 grew 6.0% in the fourth quarter vs. the third quarter and are up 9.6% from a year ago.  The best news was that profits in all major areas were up. Profits from domestic non-financial industries grew 2.5% in the fourth quarter, while profits from domestic financial firms rose 8.8%.  Profits from the rest of the world jumped 20.2% for the quarter.  Financial industry data include the Federal Reserve (either profits, or losses) and because the Fed pays private banks interest on reserves it has been generating unprecedented losses in recent years.  However, that changed in Q4 with the Fed earning positive profits for the first time since 2022. Excluding the Fed (because we want to accurately count profits in the private sector), overall corporate profits were up 5.1% in the fourth quarter and up 8.2% from a year ago.  One note of caution is that 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 slightly lower from last month’s estimate, coming in at a 0.5% annual rate, finishing 2.0% higher in 2025. A downward revision to inventories more than offset small upward revisions to business investment and government purchases.  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 1.8% annual rate in Q4, slightly lower than last month’s prior estimate of 1.9% and marking the lowest quarterly growth rate in three years, but still up 2.4% from a year ago.  Today we also got Q4 Real Gross Domestic Income (GDI), an alternative measure of economic activity.  Real GDI was up at a 2.6% annual rate in Q4 and up 2.4% from a year ago.  GDP inflation was revised slightly lower to a 3.7% annual rate in Q4, and is up 3.3% over the past year, both still higher than the Fed’s 2.0% target.  In other news this morning, cars and light trucks were sold at a 16.3 million annual rate in March, up 3.7% from February but down 8.7% from a year ago.

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Implications:  New orders for durable goods declined for the third consecutive month in February, falling 1.4%. However, the details reveal more promising underlying currents than the headline suggests. The drop in new orders was mainly due to a 5.4% drop in transportation equipment – particularly a 28.6% drop in commercial aircraft. Transportation is a notoriously volatile category month to month, so we prefer to focus on orders excluding transportation for a better check on the broader economy. Orders excluding transportation continue to rise, up 0.8% in February and 6.0% in the past year, the largest annual gain since 2022. The increase in these orders was led by primary metals (+2.2%), industrial machinery (+1.5%), and fabricated metal products (+0.5%).  The only category outside transportation to decline in February was once again electrical equipment.  However, orders for electrical equipment are still up a healthy 5.0% in the past year.  Note that both primary metals and computers & electronic products have had strong growth recently, with each experiencing double-digit annualized growth in the past three months.  Particularly, primary metals are up at a 25.4% rate in that time frame.  Arguably the most important number in today’s release is core shipments – a key input for business investment in the calculation of GDP – which rose 0.9% in February.  If unchanged in March, core shipments would rise at a 5.3% annualized rate in Q1 versus the Q4 average.  Business investment has shown strength recently as core shipments have consistently risen since mid-2025, which is a good sign for manufacturing headed into the economic shake-up of the Iran War. The investment momentum could also be evidence of Trump Administration’s push for manufacturing reshoring beginning to take hold.  However, for the Administration’s goals to fully materialize, it will have to translate into a much-needed resurgence in payrolls in that sector in the year ahead.

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Implications:  After expanding at the fastest pace in over three years last month, the service sector expanded once again in March, albeit at a slower pace, as the ISM Services Index declined to 54.0 from 56.1. Underlying activity in the sector continues to show strength, as the decline was driven largely by uncertainty surrounding the war in Iran.  Looking at the details, thirteen out of the eighteen major service industries reported growth in March, while three reported contraction and two remained unchanged.  The major measures of activity were mixed.  After climbing for five consecutive months, the business activity index declined to 53.9 from 59.9.  Meanwhile, the new orders index once again jumped to 60.6, reaching the highest level in more than three years.  Both the business activity index and the new orders index have expanded in at least ten out of the last twelve months.  Survey comments paint a picture of both headwinds and tailwinds for service companies which briefly benefitted from a reduction in tariffs from the Supreme Court ruling in mid-February, but now face increased economic uncertainty surrounding the Middle East. As a result, companies which started to increase hiring efforts at the start of the year brought hiring efforts to a halt in March. After the three months of expansion, the employment index fell into contractionary territory in March, declining to 45.2 from 51.8, although breadth in the decline was limited, as only six industries reported a decline in employment versus five that reported growth. Unfortunately, the highest reading of any index was once again the prices index, which jumped to 70.7 in March, 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 very slowly over the last 3+ years – for whether these signals turn into long-term inflationary pressure.

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Implications: Good headlines, tepid details.  A month ago some analysts and investors got scared about a decline in jobs and increase in the unemployment rate in February.  Instead, we said it was “not a reason to panic,” that we were not in recession, and the factors dragging down jobs in February – weather and a temporary nurses’ strike – should reverse in March.  And that’s exactly what happened.  Nonfarm payrolls rose 178,000 in March, the largest gain for any month since 2024.  Excluding government as well as health care & education (which are often driven by government policies), payrolls rose 95,000 in March, also the most in more than a year.  Better, these gains happened at the same time the federal government (excluding the Post Office and Census) declined 16,000, bringing the total drop since January 2025 to 346,000, the steepest since at least 1990.  Meanwhile, the unemployment rate declined to 4.3% in March from 4.4% in February.  Unfortunately, the details for March were not nearly as strong as the headlines and we should expect much smaller payroll gains in the months ahead.  Civilian employment, an alternative measure of jobs that includes small-business start-ups, declined 64,000 in March; the reason the unemployment rate declined was because the labor force (people who are either working or looking for work) declined 396,000.  And in spite of the gain in payrolls, total private-sector hours worked declined 0.2% in March, as the average worker with a job worked fewer hours.   In addition, average hourly earnings rose a mediocre 0.2%, widely lagging what is expected to be a spike in consumer prices for March due to the Iran War.  That 0.2% gain means average hourly earnings are up only 3.5% from a year ago, the smallest increase for a twelve-month period since 2021.  Cutting through the volatility, in the past year private-sector payrolls are up 42,000 per month and we think that’s probably close to a “new normal” for an economy in which, for better or for worse, immigration laws are being strictly enforced and net immigration is likely near zero.

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In 2024, Republicans swept the White House, Senate, and House, which let them make the Trump tax cuts permanent.  But the clock is ticking on their congressional majorities.

At this point, we think the odds are very high that the Democrats win back the House in the mid-term election in November.  Compared to how they did in 2024, the Democrats only have to gain three seats to take back the House.  Historically, the party not in control of the White House – this cycle, the Democrats – have gained at least three House seats in eighteen of the twenty mid-term cycles since the end of World War II.

The Democrats are polling much better than they did in 2024, when the GOP won the national House vote by 2.7 percentage points.  Today the Democrats are up in the “generic” House polling average by 6.0 points, according the RealClearPolitics.  A swing of 8.7 points against the Republicans should generate a loss of about 25 House seats.  However, keep in mind that in the 2018 midterms the generic ballot showed the Democrats up by 12%+ at one point and they won by a smaller 8.4 point margin, so there’s still time for the GOP to improve.

Yes, mid-cycle changes in district lines around the country could slightly favor the Republicans, but not enough to make up for a loss of 25 seats.  Many Republicans had been hoping a Supreme Court case heard last year would give them more options for redistricting.  But it now looks like that decision will arrive too late to help much in 2026, even though it should help them substantially in 2028. For this year, unless the polls improve for the GOP, changes in district lines might help hold their losses to about 20 seats.

However, Republican prospects look much better for keeping control of the Senate.  The last time these same states were in play was 2020, a year when President Biden beat Trump by about 4.4 points in the popular vote.  In other words, even if this cycle is bad for the GOP, it won’t be much worse than the last time these same seats were up for grabs.

Yes, the Republicans have to defend most of the seats up for grabs this year, but of the twenty-two they have to defend, twenty are in what we would describe as “Red” states, where it will be tough for the Democrats to flip even one of these seats and they might end up flipping zero. That leaves only two “Purple”-state Republican seats that are vulnerable: North Carolina and Maine.

In North Carolina, the Republican is retiring and the Democrats have the inside track.  But in Maine the Republican incumbent, Susan Collins, is running again and she has a proven track record of winning in years that are bad for the GOP nationally, like in 2008 and 2020, as well as doing much better than the polls suggest in each of her past three races.

As a result, we think the most likely outcome is a divided Congress with the Democrats running the House but the GOP still in control of the Senate.

What will this mean for policy? Starting in January 2027, every bill that reaches the president’s desk is going to have to be at least a little bipartisan to get there.  We think spending deals will be cut in Congress, but, like in so many other arenas, President Trump will push the legal limits and we expect him to exercise “impoundment” powers that haven’t been used since the early 1970s.  This will lead to a legal fight about how much leeway presidents have to refuse to spend money appropriated by Congress.

In turn, if Trump wins that fight, all future presidents will have greater authority to reduce spending.  It would be a “one-way” ratchet, and future presidential candidates could run on their willingness to stand athwart Congress yelling “stop spending so much.”  If so, we think the American people would have more options to get our long-term fiscal house in order.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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In this week’s edition of “Three on Thursday,” we look at the Federal Reserve’s financials through year-end 2025. Back in 2008, the Federal Reserve (the “Fed”) embarked on a novel experiment in monetary policy by transitioning from a “scarce reserve” system to one characterized by “abundant reserves.” In addition to inflation, this experiment has resulted in some other developments that are worrisome. For deeper insights, click on the link below.

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