In this week’s edition of “Three on Thursday,” we delve into the current state of student loan debt in the United States—a subject that has risen to the forefront of national political discourse. With student loan debt constituting over 9% of total household debt, it stands as the second largest category of consumer debt, trailing only behind mortgages. As of the end of fiscal year 2023, total outstanding student loan debt reached a staggering $1.73 trillion, with more than 40 million unique loan recipients.

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Implications:   The Fed is not going to like today’s report on GDP.  Yes, real GDP growth came in surprisingly slow in the first quarter, growing at a lukewarm 1.6% annual rate versus a consensus expected 2.5% pace.  That 1.6% rate is the slowest growth rate in almost two years and lower than the forecast from any economics group on Bloomberg.  However, we like to focus on “Core” GDP, which includes consumer spending, business fixed investment, and home building, while excluding government purchases, inventories, and international trade, the latter of which are very volatile from quarter to quarter.  Core GDP increased at a healthy 3.1% rate in Q1, with consumer spending growing at a 2.5% annual rate, fixed business investment growing at a 2.9% rate, and home building up at a 13.9% rate.  Meanwhile, inflation remained a big problem in the first quarter, with GDP prices up at a 3.1% annual rate, personal consumption prices up at a 3.4% pace, and core consumption prices up at a 3.7% rate.  None of these figures are close enough to the Federal Reserve’s 2.0% target for monetary policymakers to start cutting rates.  Nominal GDP – real GDP growth plus inflation – increased at a 4.8% rate in Q1 but is still up 5.5% from a year ago.  Yet another figure indicating that a tighter monetary policy has yet to seriously bite.  In turn, this means short-term interest rates will stay higher for longer and the risk of an eventual recession is not off the table.  Some analysts and investors believe economic growth is continuing only because of a “supply side” boom based on AI and other innovations.  But, if so, this supply-side boom would help push down inflation.  Instead, we think the economy is still feeling the lingering effects of loose money, which is keeping both growth and inflation elevated.  In other news this morning, new claims for unemployment insurance declined 5,000 last week to 207,000.  Continuing claims dropped 15,000 to 1.781 million.  Job growth continues in April.

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Implications:  Durable goods orders rose a healthy 2.6% in March, with gains heavily concentrated around the typically volatile transportation sector.  The largest gain was commercial aircraft, up 30.6% in March, while motor vehicles and parts rose a solid 2.1%.  Strip out the volatile transportation sector and orders rose 0.2% in March (+0.1% including revisions), and are up a very modest 1.0% in the past year.  Factor in inflation (which have tempered on the goods side of the economy following a surge during COVID), and orders are roughly flat over the past twelve months.  Looking at the details of the report shows rising orders across most major non-transportation categories – led by computers and electronic products (+0.8%), fabricated metal products (+0.2%), and machinery (+0.1%) – which were partially offset by declining orders for primary metals (-0.5%).  The most important number in the release, core shipments – a key input for business investment in the calculation of GDP – rose 0.2% in March and were up at a 2.0% annualized rate in Q1 versus the Q4 average.  The growth in shipments has moderated significantly since the start of 2022, and we expect this trend to continue as the economy feels the lagged effects of the Federal Reserve’s actions to tighten monetary policy.  Consistent with other economic data, orders and shipments for durable goods have been choppy of late, and we expect a number of factors will keep the path forward rocky as we move through 2024: monetary policy from the Federal Reserve, the withdrawal symptoms following the COVID-era economic morphine that artificially boosted both consumer and business spending, and the ongoing shift toward services that likely means goods-related activity will soften in the year ahead, even as some durables that facilitate services remain healthy.  In other recent news, the Federal Reserve reported yesterday that the M2 measure of the money supply rose 0.4% in March, but remains down 0.3% from a year ago, and is down 4.1% from the peak in April 2022.  This is not a good sign for Real GDP growth in the year ahead and consistent with our view that recession risks remain.

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Implications:  New home sales came in stronger than expected in March, driven by broad-based gains as more inventories give buyers a greater number of options to choose from. Notably, the 8.8% gain in March was the largest in more than a year.  It looks like the upward trend in new home sales that began in 2022 as the economy reopened is still intact, though volatility in interest rates continues to play an outsized role.  Mortgage rates have been surging again recently due to a recent string of bad inflation reports that have led to expectations of fewer cuts by the Federal Reserve in short term interest rates later this year.  Expect an impact on new home sales in April’s report (due in a month) as higher financing costs once again hit affordability. Assuming a 20% down payment, the rise in mortgage rates since the Federal Reserve began its current tightening cycle amounts to a 28% increase in monthly payments on a new 30-year mortgage for the median new home.  The good news for potential buyers is that the median sales price of new homes has fallen 13.3% from the peak in 2022.  However, it’s important to note that this drop in median prices is likely due to the mix of homes on the market including more lower priced options as developers complete smaller properties. 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 nearly 190% versus the bottom in 2022. Total inventories have continued to climb higher as well, hitting a new post pandemic high in March. 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.  But this does not mean that housing is getting more affordable per square foot, with the Census Bureau reporting median prices on this basis up 45% from 2019 to 2022, the most recent data available. Though not a recipe for a significant rebound, more inventories giving potential buyers a wider array of options will continue to put a floor under new home sales.  One problem with assessing housing activity is that the Federal Reserve held interest rates artificially low for more than a decade.  With rates now in a more normal range, the sticker shock on mortgage rates for potential buyers is very real.  However, we have had strong housing markets with rates at current levels in the past, and as long as the job market remains strong, homebuyers will continue to adjust.  In manufacturing news this morning, the Richmond Fed index, a measure of mid-Atlantic factory activity, rose to -7.0 in April from -11.0 in March.

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The economy continued to grow in the first quarter at what we estimate is a 2.6% annual rate.  That’s a slowdown from the 3.1% rate in 2023, but still good compared to the past couple of decades when the average growth rate has been 2.0%.

However, we think a chunk of recent growth is artificial, and temporary, the by-product of too much government.  Directly, this includes “real” (inflation-adjusted) government purchases that grew 4.6% in 2023 and we estimate grew at a 2.3% annual rate in the first quarter.

It also includes the indirect effects of the expansion in the budget deficit in FY 2023.  The official deficit didn’t expand much, but that’s because President Biden announced a plan to forgive student loans in 2022 and then the Supreme Court struck it down in 2023.  Neither of these affected the government’s cash flow but they did change official government accounting.  Taking them out means the deficit expanded to 7.5% of GDP in FY 2023 from 3.9% in FY 2022.

In addition, and as we explained recently (MMO, April 8), if monetary policy were really tight, inflation would be persistently declining.  But CPI prices were up 3.0% in the year ending in June 2023 and are now up 3.5% in the past year.  This suggests residual effects of past monetary looseness are still boosting the economy.        

We estimate that Real GDP expanded at a 2.6% annual rate in the first quarter, mostly accounted for by an increase in consumer spending.

Consumption: “Real” (inflation-adjusted) retail sales outside the auto sector declined at a 3.0% annual rate in Q1 while auto sales declined at an 8.7% rate.  However, it looks like real services, which makes up most of consumer spending, soared at a 4.7% pace.  That’s the fastest pace for service growth since the re-opening from COVID in 2020-21.  Excluding that re-opening, when all the data were whacky, it's the fastest pace for service growth since the peak of the Internet Bubble in 2000.  Putting it all together, we estimate that real consumer spending on goods and services, combined, increased at a 3.1% rate, adding 2.1 points to the real GDP growth rate (3.1 times the consumption share of GDP, which is 68%, equals 2.1).

Business Investment:  We estimate a 2.4% growth rate for business investment, with gains in intellectual property leading the way, while commercial construction declined.  A 2.4% growth rate would add 0.3 points to real GDP growth.  (2.4 times the 14% business investment share of GDP equals 0.3).

Home Building:  Residential construction is showing some resilience in spite of some lingering pain from higher mortgage rates.  Home building looks like it grew at a 5.0% rate, which would add 0.2 points to real GDP growth.  (5.0 times the 4% residential construction share of GDP equals 0.2).

Government:  Only direct government purchases of goods and services (not transfer payments) count when calculating GDP.  We estimate these purchases were up at a 2.3% rate in Q1, which would add 0.4 points to the GDP growth rate (2.3 times the 17% government purchase share of GDP equals 0.4).

Trade:  Looks like the trade deficit expanded in Q1, as exports grew but imports grew even faster.  In government accounting, a larger trade deficit means slower growth, even if exports and imports both grew.  We’re projecting net exports will subtract 0.5 points from real GDP growth.

Inventories:  Inventory accumulation looks like it picked up in Q1, but only slightly versus Q4, translating into what we estimate will be a 0.1 point addition to the growth rate of real GDP.

Add it all up, and we get a 2.6% annual real GDP growth rate for the first quarter.  Solid for now, but we expect slower growth later this year as the temporary effects of government deficit spending wear off.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist 

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In this week’s “Three on Thursday,” we explore the Personal Consumption Expenditures (PCE) Price Index, which became the Federal Reserve’s preferred inflation gauge starting in 2000. This shift occurred after Federal Reserve Chairman Alan Greenspan highlighted its advantages in The Monetary Policy Report to Congress. The Fed favors the PCE Price Index over the Consumer Price Index (CPI) for several reasons.

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Implications:  Existing home sales took a widely expected breather in March following the largest monthly gain in a year in February. While sales activity has finally bottomed it looks like any significant recovery is still facing headwinds from mortgage rates that remain above 7%. Mortgage rates had been dropping in early 2024, but that trend has recently reversed. The culprit is a recent string of bad inflation reports that have cast doubts on the Federal Reserve following through with rate cuts this year. Meanwhile, home prices appear to be rising again, although modestly, with the median price of an existing home up 4.8% from a year ago.  The result is that affordability is still a big concern for buyers.  Assuming a 20% down payment, the rise in mortgage rates since the Federal Reserve began its current tightening cycle in March 2022 amounts to a 34% increase in monthly payments on a new 30-year mortgage for the median existing home.  Eventually, the housing market can adapt to these increases but continued volatility in financing costs will cause some indigestion.  The other major headwind for sales has been that many existing homeowners are reluctant to sell due to a “mortgage lock-in” phenomenon, after buying or refinancing at much lower rates before 2022.  This continues to limit future existing sales (and inventories).  However, there are signs of progress with inventories rising 14.4% in the past year.  That said, the months’ supply of homes (how long it would take to sell existing inventory at the current very slow sales pace) was 3.2 in March, well 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.  Putting this together, we expect a modest recovery in sales in 2024.  In other news this morning, initial claims for jobless benefits remained unchanged last week at 212,000, while continuing claims rose by 2,000 to 1.812 million.  The figures are consistent with continued job gains in April. Finally, on the manufacturing front, the Philadelphia Fed Index, a measure of factory sentiment in that region, jumped to +15.5 in April from +3.2 in March.

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Implications:  Industrial production continued to rebound in March, rising for a second month due to broad-based gains. The manufacturing sector was the main source of strength in today’s report, with activity rising 0.5%.  Auto production jumped 3.1% in March and has been a big driver of activity so far in 2024. This measure is up at a 10.1% annualized rate in the past three months, likely the result of production still getting back on track following large scale strikes late last year. Meanwhile, non-auto manufacturing (which we think of as a “core” version of industrial production) posted a moderate gain of 0.3% in March. The production of high-tech equipment also rose in March and is up 14.1% in the past year, the strongest growth of any major category.  This likely reflects investment in AI as well as the reshoring of semiconductor production. Notably, activity here has begun to slow recently signaling that the initial burst due to the CHIPS Act may finally be wearing off.  The utilities sector (which is volatile and largely dependent on weather) was also a tailwind in today’s report, rising 2.1% in March.  Finally, the one source of weakness in March came from the mining sector, with activity falling 1.4%.  Broad-based declines in oil and other mineral extraction more than offset a small increase in natural gas production.  However, given the recent jump in energy prices, we expect a rebound in mining in the next couple of months.   

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Implications:  Housing starts posted the largest monthly decline in March since the worst of the COVID pandemic, coming in well short of consensus expectations.  However, this follows a surge in starts in February and we do not see March as a sign of persistent weakness ahead in home building.  While the data have been very choppy since the Federal Reserve began the current tightening cycle two years ago, it looks like construction activity has bottomed; even with the large drop in March, starts are still above the level from last August.  Keep in mind that many owners of existing homes are hesitant to list their homes and give up fixed sub-3% mortgage rates, so many prospective buyers have turned to new builds as their best option. This has boosted demand for developers and should help construction activity going forward.  The problem is that with recent inflation reports having come in hotter than expected, the markets – and the Fed itself – seem increasingly doubtful about near-term rate cuts.  As a result, long-term interest rates have gone up including mortgage rates.  In turn, this could generate a temporary headwind for home sales and housing starts in April.  Looking at the details of the report, the slowdown in construction in March was broad-based with three out of four major regions and both single-family and multi-unit starts contributing.  Housing permits and completions also took a breather in March, dropping 4.3% and 13.5%, respectively.  Another recent theme is the split between single-family and multi-family development.  Over the past year, the number of single-family starts is up 21.2% while multi-unit starts are down 44.3%.  Permits for single-family homes are up 17.4% while multi-unit home permits are down 20.2%.  This huge gap in the data is due to the unprecedented nature of the last four years since COVID began.  While we don’t see housing as a major driver of economic growth in the near term, we don’t expect a housing bust like the 2000s on the way, either.  Builders built too few homes in the decade before COVID and that shortage should support home prices in the years ahead.  In other housing news, the NAHB Housing Index, a measure of homebuilder sentiment, remained at 51 in April.  This marks the second month in a row that the index is above 50 since last Summer, signaling that a greater number of builders view conditions as good versus poor.

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Implications:  Retail sales beat expectations in March, rising 0.7% for the month versus a consensus expected gain of 0.4%, while previous months were revised higher.  Factoring these in, retail sales grew an even faster 1.3%.  These figures add to a trove of recent reports pulling the Federal Reserve away from rate cuts starting in June.  Sales rose in eight of thirteen major categories for the month, led by a robust 2.7% gain in nonstore retailers (think internet and mail-order), followed by a 2.1% increase at gas stations, which rose largely due to higher gas prices in March.  The largest decline in March was a 0.7% drop for autos.  “Core” sales, which exclude volatile categories such as autos, building materials, and gas stations — and is a crucial measure for estimating GDP — surged 1.0% in March (+1.4% including revisions to prior months).  After looking weak in the first two months of 2024, these sales ended up increasing at a 2.2% annual rate in Q1 versus the Q4 average.  It’s important to remember that a key driver of overall spending is inflation.  While overall retail sales are up 4.0% in the last year and sit at a record high unadjusted for inflation, “real” (inflation-adjusted) retail sales are up just 0.5% in the last year, and have remained stagnant for nearly two years after peaking in April 2022.  It has been 40 years since the US had an inflation problem, so investors should be aware that it can distort data.  Our view remains that the tightening in monetary policy since 2022 will eventually deliver a recession.  In other news this morning, the Empire State Index, a measure of New York factory sentiment, rose to -14.3 in April from -20.9 in March.

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