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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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  Three on Thursday - The Current State of Nuclear Energy
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In this week’s installment of “Three on Thursday,” we take a look at nuclear power. Nuclear energy is a crucial component of the global energy landscape. Unlike fossil fuels, nuclear power plants produce a substantial amount of electricity without emitting greenhouse gases, making them a key player in reducing carbon footprints and achieving net-zero emission goals. 

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Posted on Thursday, May 23, 2024 @ 12:18 PM • Post Link Print this post Printer Friendly
  New Single-Family Home Sales Declined 4.7% in April
Posted Under: Data Watch • Employment • Government • Home Sales • Housing • Inflation • Fed Reserve • Interest Rates
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Implications:  There wasn’t much to get excited about in today’s report on new home sales, which fell 4.7% in April.  It looks like activity is stuck in low gear, with sales having normalized roughly at the same pace they were in 2019 before COVID.  Stubbornly high inflation continues to be the biggest headwind to a broader recovery, with 30-year fixed mortgage rates remaining above 7%. Assuming a 20% down payment, the rise in mortgage rates since the Federal Reserve began its current tightening cycle amounts to a 32% 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 6% 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 over 200% versus the bottom in 2022. Total inventories have continued to climb higher as well, hitting a new post pandemic high in April. 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, and buyers started to believe those low rates were normal.  With rates now reflecting true economic fundamentals, 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 and buyers understand that the past was a mirage, it’s possible they will eventually adjust.  In other news this morning, initial claims for jobless benefits fell 8,000 last week at 215,000, while continuing claims rose by 8,000 to 1.786 million.  The figures are consistent with continued job gains in May.

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Posted on Thursday, May 23, 2024 @ 12:04 PM • Post Link Print this post Printer Friendly
  Existing Home Sales Declined 1.9% in April
Posted Under: Data Watch • Government • Home Sales • Housing • Inflation • Markets • Fed Reserve • Interest Rates
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Implications:  Existing home sales continued to recede in April, likely the result of a normalization in activity following a larger than expected gain back in February. Sales are also still facing headwinds from mortgage rates that remain above 7%. Meanwhile, home prices appear to be rising again, although modestly, with the median price of an existing home up 5.7% 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 42% 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. Notably, homes priced at $1 million and above have seen inventories and sales rise 34% and 40%, respectively, in the past year. This demonstrates that, at least at the higher end of the market, both buyers and sellers are adjusting to the new reality of higher rates. That said, outside the most expensive segment 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 remains a major headwind to activity by limiting future existing sales (and inventories).  However, there are signs of progress with inventories rising 16.3% 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 3.5 in April, 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 sales to be higher this year than in 2023.

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Posted on Wednesday, May 22, 2024 @ 11:53 AM • Post Link Print this post Printer Friendly
  Are Abundant Reserves Paying for the CFPB?
Posted Under: Government • Inflation • Markets • Monday Morning Outlook • Fed Reserve • Interest Rates • Spending • Bonds • Stocks

Back in 2008, the Federal Reserve made important changes in the way it handles monetary policy.  We’ve written about them several times, but few really understand.  The press won’t ask questions about it and few economists discuss them.  They seem nuanced and arcane, and they are, but they are also massively important, and potentially dangerous.

With Quantitative Easing, the Fed shifted from a scarce reserve model to an abundant reserve model.  The flood of new money grew the Fed’s balance sheet from $870 billion in August 2008 to its current level of $7.4 trillion.  That’s a 747% increase.  The Fed was just 5% of the size of the economy in 2008, today it exceeds 25%.

In order to contain the potential inflation from all this money the Fed has raised banks’ capital requirements and increased liquidity demands.  Despite being flush with reserves, banks are constrained in making loans, holding three to four times more reserves as a share of deposits than they did in 2007 before all these changes happened.

One result of this is that banks no longer trade federal funds.  They don’t need to because they all have excess reserves, the system as a whole is flooded with them.  

When banks had scarce reserves, interest rates were a signal about the demand for money because banks borrowed and lent reserves every day.  With reserves now piled everywhere, there is no market for federal funds and the Fed sets rates wherever it wants them…with or without regard to the demand for money.

Because the Fed is a creature of Washington DC, political pressure plays a role.  And, when it comes to politics, low rates are better than high rates.  Not for savers, but for car loans or mortgages and also for a government running large deficits.

As a result, the Fed has held interest rates below inflation 80% of the time since 2008, and at roughly 0% for nine out of the past fifteen years.  This policy is now creating real problems.  Everyone got used to low interest rates; banks acted like they would last forever and made loans or bought bonds at artificially low interest rates.  But QE and an abundant reserve policy were playing with fire.  With all that money in the system, an inflationary mistake was inevitable.

And with higher inflation comes higher interest rates.  So, to put this in historical perspective, a policy (QE) that was implemented in order to counteract less than $400 billion in losses from subprime loans has created unrealized losses on bank balance sheets of more than $680 billion as of Q3 2023 (and the Fed itself has seen unrealized losses on their own balance sheet approach $1 trillion).  When rates rise, the value of loans and bonds falls.  It’s why we are seeing bank failures these days.

The key difference is that in 2008, the US was enforcing mark-to-market accounting.  This caused a relatively small problem to become a massive problem, a panic.  Today, banks don’t have to mark those losses to market and the system is much more stable.  But please don’t ignore the fact that we have nearly double the losses on bank books today than we did in 2008.

Another problem with this new policy is that the Fed bought the same bonds the banks did during the low-rate environment.  And because the Fed decided to pay banks to hold reserves, it is now paying more in interest to banks than it is earning on the bonds in its portfolio.  

We have asked many times before: if the Fed is losing $100 billion dollars a year, how does it pay its staff?  Apparently, the answer is: by borrowing from the Treasury with a promise to repay when it makes profits in the future.  In other words, the taxpayer is now footing the bill for this new method of managing monetary policy.  

And that brings us to our final point.  The Supreme Court ruled last week that the Consumer Finance Protection Bureau (CFPB), by a vote of 7-2, could remain an independent agency even though it wasn’t funded by Congress like other agencies, but instead by the Fed.  

The problem with the Court’s logic is that the Federal Reserve is now losing money every day.  The only way it can pay for the CFPB is to use taxpayer money by borrowing directly from the Treasury. So, the CFPB is deemed “independent” because it doesn’t rely directly on Congress for funding, but in reality it is spending taxpayer funds when the Fed runs losses.

But even if the Fed were making a profit, (as it was when it was paying banks 0% on reserves while earning money on its portfolio of bonds) and remitting that money to the Treasury, it would be holding back funds in order to pay for the CFPB. In other words, no matter how you cut it, the Fed ultimately gets all its resources from the taxpayer…either through the cost of inflation, by remitting less to the Treasury, or by borrowing from the Treasury when it is not running a profit.

If the Supreme Court understood the complications of monetary policy, especially after the changes implemented in 2008, we would have expected a different ruling.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist 

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Posted on Monday, May 20, 2024 @ 11:39 AM • Post Link Print this post Printer Friendly
  Three on Thursday - The State of Social Security
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In this week’s “Three on Thursday,” we delve into the state of Social Security. Originating from the Social Security Act of 1935 as part of President Franklin D. Roosevelt’s New Deal, the program initially provided income to retired workers aged 65 or older. Since then, it has grown to include disability insurance, survivor benefits, and Supplemental Security Income (SSI), becoming a vital support for millions. However, recent projections indicate that Social Security is nearing insolvency, necessitating urgent reforms. 

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Posted on Thursday, May 16, 2024 @ 11:36 AM • Post Link Print this post Printer Friendly
  Industrial Production Remained Unchanged in April
Posted Under: Data Watch • Industrial Production - Cap Utilization • Markets
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Implications:  Industrial production took a breather in April following two months of gains, with the details even weaker than the headline number. The manufacturing sector was the biggest drag on activity in today’s report, falling 0.3%.  Auto production posted a decline of 1.9%, likely the result of a normalization following production surging earlier this year to get back on track following large scale strikes in late 2023. Meanwhile, non-auto manufacturing (which we think of as a “core” version of industrial production) posted a decline of 0.1% in April and is down 0.5% from a year ago. One bright spot in manufacturing in April was the production of high-tech equipment, which jumped 1.0%. This measure is up 9.4% in the past year, the strongest growth of any major category, likely the result of investment in AI as well as the reshoring of semiconductor production. That said, activity here has begun to slow recently signaling that the initial burst due to the CHIPS Act may finally be wearing off.  The mining sector was also a source of weakness in April, with activity falling 0.6%.  Declines in the drilling of new wells and the extraction of other minerals and metals more than offset a gain in the production of oil and gas.  Finally, the utilities sector (which is volatile and largely dependent on weather) was the biggest source of strength in today’s report, rising 2.9% in April. In other news this morning, the Philadelphia Fed Index, a measure of factory sentiment in that region, fell to +4.5 in May from +15.5 in April.

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Posted on Thursday, May 16, 2024 @ 11:30 AM • Post Link Print this post Printer Friendly
  Housing Starts Rose 5.7% in April
Posted Under: Employment • Government • Home Starts • Housing • Inflation • Markets • Fed Reserve • Interest Rates
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Implications:  Housing starts rebounded in April but remain below the pace of late 2023.  The main culprit weighing on activity is mortgage rates, which have lingered higher for longer in response to higher inflation reports in recent months.  However, it’s important to keep in mind that many owners of existing homes are hesitant to list their homes and give up fixed sub-3% mortgage rates, so prospective buyers have turned to new builds as their best option. This has boosted demand for developers and should keep a floor under construction activity going forward.  Looking at the details of the report, the gain in April was entirely due to a 30.6% jump in multi-family starts, while single-family starts remained essentially unchanged, down 0.4% from the previous month.  It looks like homebuilders were more focused on completing homes in April versus new builds, as housing completions for single-family homes jumped 15.4%, the second largest monthly gain since 2019. 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 17.7% while multi-unit starts are down 33.1%.  Permits for single-family homes are up 11.4% while multi-unit home permits are down 21.9%.  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, fell to 45 in May from 51 in April.  A reading below 50 signals a greater number of builders view conditions as poor versus good.  In other news this morning, initial claims for jobless benefits fell 10,000 last week at 222,000, while continuing claims rose by 13,000 to 1.794 million.  The figures are consistent with continued job gains in May.  Finally, on the trade front, import prices jumped 0.9% in April and export prices increased 0.5%.  In the past year, import prices up 1.1% while export prices are down 1.0%.

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Posted on Thursday, May 16, 2024 @ 11:18 AM • Post Link Print this post Printer Friendly
  The Consumer Price Index (CPI) Rose 0.3% in April
Posted Under: CPI • Data Watch • Government • Inflation • Markets • Fed Reserve • Interest Rates • Bonds • Stocks
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Implications:   Headline inflation came in a bit softer than expected in April, but it’s still a long way to go before the Fed can declare victory.   Despite today’s moderately good news, it looks clear that the progress against inflation made from mid-2022 to mid-2023 has stalled.  Consumer prices were up 9.1% in the year ending in June 2022.  Then the rapid drop back to 3.0% in the year ending in June 2023 made many believe the end of “temporary” pandemic inflation problems was in sight. Since then, baseline inflation has remained stubbornly sticky above 3%, casting doubt on the Fed’s ability to cut rates in 2024.  Looking at the details, April inflation was boosted by energy prices, which rose 1.1% on the back of higher prices for gasoline and other fuels.  However, it’s important to point out that energy has not been the culprit for the stubbornly high inflation readings over the last year; energy prices are up 2.6% in the same timeframe versus 3.4% for overall prices.  Stripping out energy and its often-volatile counterpart (food) to get “core” prices does not make the inflation picture look any better.  That measure rose 0.3% in April, is up 3.6% in the past year, and up an even faster 4.1% annual rate over the past three months, showing that underlying inflation pressure remains stubbornly high.  While “core” prices did get some help from softer shelter costs in April, that was due to a 0.2% decline in prices for lodging away from home (think hotels). Meanwhile rental inflation – both for actual tenants and the imputed rental value of owner-occupied homes – continues to defy predictions of imminent reversal, rising 0.4% for the month and running at or above a 5% annualized rate over three-, six-, and twelve-month timeframes.  Housing rents have been a key driver of inflation over the last year, and we expect this to continue, as rent makes up a third of the weighting in the overall index and still hasn’t caught up with the rise in home prices in the past four years.  Finally, the most troublesome piece of today’s report for the Federal Reserve came from a subset category of prices that the Fed itself has told investors to watch closely – known as the “Supercore” – which excludes food, energy, other goods, and housing rents, and is a useful gauge of inflation in the service sector.  That measure jumped 0.4% in April, driven by higher prices for motor vehicle insurance (+1.8%) and financial services (+2.5%).  In the last twelve months, this measure is up 4.9% and has been accelerating as of late; up at a 6.3% annualized rate in the last three months.  And while inflation remains stubbornly high, workers are no longer being compensated for it.  Case in point, real average hourly earnings declined 0.2% in April.  These earnings are up only 0.5% in the last year, a headwind for future growth in consumer spending.  Putting this all together, the Fed has little reason at this point to start cutting rates.  How they respond to the incoming economic data in the months ahead could determine whether we repeat the inflationary 1970s.

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Posted on Wednesday, May 15, 2024 @ 11:09 AM • Post Link Print this post Printer Friendly
  The Producer Price Index (PPI) Rose 0.5% in April
Posted Under: Government • Inflation • Markets • PPI • Fed Reserve • Interest Rates • Bonds • Stocks
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Implications:   April producer prices came in hotter than expected, and certainly higher than what the Fed was hoping to see.  Following a breather in March, producer prices rose an outsized 0.5% in April, and have been accelerating of late.  Over the last three months, producer prices have risen at a 4.1% annualized pace, while year-ago comparisons are on the rise and now back above 2.0% for the first time since April of last year.  While tomorrow’s report on consumer prices will garner more attention, it looks unlikely the Fed is going to feel increased confidence that inflation is moving sustainably toward its 2.0% target.  In turn, that means rates are likely to stay higher – for longer – than markets were anticipating earlier this year.   Looking at April itself, service costs lead the index higher, rising 0.6% on the month.  Prices for services less trade, transportation, and warehousing (+0.6% in April) accounted for more than two-thirds of the services cost increase, while margins to wholesalers rose 0.8%.  Goods prices didn’t provide any relief, rising 0.4% in April lead by higher energy costs (+2.0% in April).   That said energy prices – along with food prices – tend to be volatile month-to-month, and April was no exception.  Stripping out these two components shows “core” prices rose 0.5% in April. Core prices dipped below 2.0% on a year-ago basis back in November of last year, but have turned back higher and are now up 2.4% in the past twelve months.  While the Fed can take some solace in that the twelve-month rise in core prices has eased since peaking at 9.7% back in March of 2022, they will be less than enthused about the breach back above 2.0%, nor will they welcome the acceleration over recent months, with core prices up 3.2% annualized in the past three months.   Further back in the supply chain, prices in April rose 0.6% for intermediate demand processed goods and 3.2% for unprocessed goods. Further easing in inflation will come should the Fed have the patience to let a tighter monetary policy do its work.  But inflation risks re-acceleration should the Fed falter and cut rates too quickly.  The question on many minds coming in to 2024 was if the Fed could orchestrate a soft landing, now it’s looking increasingly possible that the Fed may not have clearance to start landing procedures before the year is through.

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Posted on Tuesday, May 14, 2024 @ 11:28 AM • Post Link Print this post Printer Friendly
  Would Trump Reignite Inflation?
Posted Under: Government • Inflation • Markets • Monday Morning Outlook • Trade • Fed Reserve • Interest Rates • Bonds • Stocks

One theory making the rounds is that if President Trump gets back into office, inflation is going to surge.  The idea is that if he returns, Trump will raise tariffs, reduce immigration, and jawbone the Federal Reserve to cut interest rates too much, all of which could push inflation higher, maybe even to where it was a couple of years ago when it peaked at 9.1%.

We are certainly not optimistic about the path of inflation in the decade ahead. The Consumer Price Index (CPI) went up at only a 1.8% annual rate in the ten years prior to COVID and we think it’ll be closer to 3.0% per year in the decade ahead.  However, we think that’ll likely be the case regardless of the election results later this year.  At the same time, we don’t expect anything like the COVID surge in inflation in the next few years.

Take the tariff argument, for example.  Yes, tariffs would raise prices for the items being tariffed.  But unless the Fed loosens monetary policy in response, the extra money consumers would have to spend on imported items would have to come from money they’d otherwise use to buy other items, putting downward pressure on prices for those other items and not changing overall inflation.  Remember, Trump raised tariffs during his first term in office and yet inflation was subdued until the Fed ignited it during COVID.

The same goes for immigration, which was slower in the Trump Administration than it had been under President Obama, without causing a spike in inflation.  By contrast, immigration has soared under President Biden while the CPI has averaged 5.6% per year.  If immigration was some sort of magic that kept inflation low, why wasn’t inflation much higher during Trump and why hasn’t it been lower under President Biden?

We think this is ultimately because it’s monetary policy that determines inflation, not tariffs or immigration.  Which brings us to the last argument suggesting Trump will bring back high inflation, that he will put political loyalists in charge of the Fed who will loosen policy much more than economic conditions suggest, leading to a spurt in inflation.

It is true that Trump would have the chance to put loyalists at the Fed, but the terms of Fed policymakers turn over gradually.  Also, every nominee would need confirmation by the Senate.  None of these people, not the nominee or nominators, would want to be blamed for causing a surge in inflation.

We are guessing Trump would appoint either Kevin Warsh or Kevin Hassett as Fed chairman to succeed Jerome Powell, neither of whom would want to go down in history as the second coming of the failed Arthur Burns of the 1970s.  Moreover, many of the votes on monetary policy come from regional bank presidents not appointed directly by the president.  The Fed is full of checks and balances, and part of a new Fed regime’s task will be to fix the inflationary tilt of policy since 2008.

Again, we are not saying inflation won’t be a problem in the years ahead; it likely will be.  But it’s likely to be a problem no matter who wins this November.  

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist 

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Posted on Monday, May 13, 2024 @ 10:06 AM • Post Link Print this post Printer Friendly

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