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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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  New Single Family Home Sales Increased 1.5% in January
Posted Under: Data Watch • Government • Home Sales • Housing • Markets • Fed Reserve • Interest Rates
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Implications:  New home sales started 2024 on a positive note, rising for a second month in a row in January, though data from previous months were revised down. While the past two months could suggest the worst of the headwinds for new home sales are in the rearview mirror, new home sales are still 5.3% lower than what they were last Fall. The main issue with the US housing market has been affordability, so it’s not surprising that 30-yr fixed mortgage rates recently falling roughly 1% due to anticipation of Fed rate cuts in 2024 has helped sales activity over the past couple months.  That said, higher financing costs are still taking a bite out of buyer’s purchasing power. Assuming a 20% down payment, the rise in mortgage rates since the Federal Reserve began its current tightening cycle amounts to a 20% 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 by 15.3% 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 160% 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.  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 eventually adjust.

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Posted on Monday, February 26, 2024 @ 1:27 PM • Post Link Print this post Printer Friendly
  Watching the Fed
Posted Under: Durable Goods • Employment • GDP • Government • Home Sales • Housing • Industrial Production - Cap Utilization • Inflation • Markets • Monday Morning Outlook • PIC • Fed Reserve • Interest Rates • Bonds • Stocks

Every day this week, investors will get data on the economy.  New home sales today, then capital investment, GDP, consumer incomes and spending, manufacturing, and auto sales are on the list.  All of this will feed into the outlook for what the Federal Reserve might do with interest rates this year.

Pretty much everyone expects the Fed to cut rates this year, but expectations have changed.  A month ago, the futures market was pricing in five or six twenty-five basis point (bps) rate cuts in 2024 (125 - 150 bps in total); now the market is pricing in three or four (75 - 100 bps total).  Two relatively strong employment reports and an upside surprise with Q4 GDP data caused some rethinking, but this could be reversed just as easily.

While all these data points matter, we will be watching another release very closely, as well, one that few investors pay attention to and the Fed itself either doesn’t care about or is doing a great job pretending it doesn’t care about: tomorrow afternoon’s report on the growth of the money supply, or lack thereof, the M2 measure of money, in particular.

That measure of money, in spite of QE, did not soar during the Great Recession and Financial Crisis of 2008-09, and therefore did not cause inflation.  The main reason is that though the Fed did trillions in QE, through heavy-handed regulation, banks were forced to boost reserves.

But 2020-21 was different.  Banks were paid to push the money into the economy (remember PPP loans?) and M2 skyrocketed 40.7%.  This led to the surge in inflation that followed in 2021-22.  Since then, M2 has actually declined 3.2% in 2022-23, taking the steam out of inflation, but so far hasn’t affected economic growth.

But in the last two months of 2023, M2 started growing at a moderate pace again, up at a 4.1% annualized rate.  If the Fed keeps it up, not just for one month but as a trend, that would be good news and might even reduce the risk of a recession later this year.

While we watch M2, others have been eyeing the relationship between long and short interest rates.  In October 2022, the 3-month Treasury yield rose above the 10-year yield, and has stayed there.  This is called an “inverted yield curve” and historically signals that the Fed is tight and a recession is often on the way.

But in an “abundant reserve” monetary policy, higher short-term interest rates no longer signal “tight” reserves.  In fact, with reserves so abundant, the Federal Funds Rate is no longer determined in a market, but is actually set at the whim of the Fed.  Technically, this is price fixing.

So, the yield curve doesn’t mean what it once did.  Longer-term bond yields now are hugely affected by what investors think the Fed might do with rates, rather than how those rates reflect underlying economic trends.  The Fed has convinced itself and the markets, that it can move rates up and down with the economic data perfectly, but this is hubris.  The Fed has held interest rates below inflation roughly 80% of the time since 2009, leading to distortions in markets and the banking system.

Having said that, with short-term rates no longer excessively low, and the money supply down in the past 18 months, we believe the economy is starting to falter.

Retail sales have declined in three of the past four months.  Manufacturing production, excluding the auto sector has declined four months in a row.  Meanwhile, home building got hammered, with both housing starts (-14.8%) and completions (-8.1%) dropping sharply while new home sales are down 5.3% in the past four months.

We advise watching the path of M2 to tell how much additional faltering it will do in the year ahead.  

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist 

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Posted on Monday, February 26, 2024 @ 12:53 PM • Post Link Print this post Printer Friendly
  Three on Thursday - The Era of Abundant Reserves
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Few people grasp the profound changes our monetary and banking systems underwent when Ben Bernanke was Federal Reserve Chair and Hank Paulson was Treasury Secretary. This week’s edition of “Three on Thursday” is our attempt to highlight some of these unprecedented changes. To further the discussion, click on the link below.

Click here to view the report

Posted on Thursday, February 22, 2024 @ 4:16 PM • Post Link Print this post Printer Friendly
  January Stagflation
Posted Under: CPI • Employment • GDP • Government • Home Starts • Housing • Inflation • Markets • Monday Morning Outlook • PPI • Retail Sales • Fed Reserve • Interest Rates • Spending • Bonds • Stocks • COVID-19

A key economic mistake people make is thinking growth leads inflation.  One reason they do that is because inflation is a monetary phenomenon.  When money is too easy, first growth rises, and then inflation rises with a longer lag due to excess dollars in the system.  This process reverses when money is tight, first growth slows, then with a longer lag inflation does too.

That makes 2023 an anomaly.  The economy has remained resilient, but year-over-year consumer price inflation has moderated from a peak of 9.1% in mid-2022 to 3.4% in December 2023.

One theory is that the high inflation was all due to economic bottlenecks and supply constraints during COVID, so the end of lockdowns and the process of getting back to normal has expanded supply, leading to both faster growth and lower inflation.  There’s no doubt that the imposition of lockdowns and then the re-opening from those lockdowns had “supply-side” effects – first negative, then positive – and are consistent with this explanation.

But it’s a flawed explanation.  If supply constraints and their loosening were the key drivers of inflation, we would expect pandemic driven inflation to be followed by outright deflation as the economy reopened and returned to normal.  That clearly hasn’t happened, and inflation remains stubbornly high.

Instead, we believe monetary policy played the key role.  The M2 measure of the money supply soared 41% in 2020-21, the fastest since World War II.  This measure of the money supply then declined 3.2% in 2022-23, the largest two-year drop since the Great Depression.  These swings in M2, the relative sizes of the swings (larger up than down), and the long lags between shifts in M2 and inflation do a much better job explaining the inflation pattern of the past few years.

The problem with this theory of “monetary dominance” is that classical liberals like Milton Friedman and the Austrians would expect economic growth to take a hit before inflation were brought back down to normal.  And yet Real GDP grew 3.1% in 2023, which is above the 2.0% long-term trend.

So what gives?  Our belief is that the US injected so much money, so rapidly, that the economy couldn’t absorb it instantaneously.  So, now, what we have seen is that even though M2 has declined, we still haven’t absorbed all the money that was added.  Some call it excess savings, we call it excess M2.

But the US has finally absorbed the excess money, and fiscal stimulus is waning as well.  And guess what?  Recent reports for January show an economy that may be weakening faster than most investors realize.  Retail sales fell 0.8% for the month and have declined in three of the past four months.  Manufacturing production fell 0.5% in January and manufacturing excluding the auto sector (the auto sector is volatile) has declined four months in a row.

Meanwhile, home building got hammered in January, with both housing starts (-14.8%) and completions (-8.1%) dropping sharply.  It’s possible that colder than normal January temperatures were a factor, as well as unusually high precipitation, but the drop in starts was in every major region of the country, the drop in completions happened in most regions (except for the West), and while weather was bad, quantitative measures of national heating requirements were not unusually high in January.

We’ve had bad weather before – and apocalyptic weather reports are clearly clickbait for some in the news media – but housing starts in January were the second lowest for any month since mid-2020, during the onset of COVID when lockdowns still prevailed in much of the country.  In other words, we see these data potentially signaling broader economic weakness, consistent with the drop in retail sales and decline in manufacturing production in January.

And yet inflation was also a problem in January, with both consumer and producer prices rising 0.3%, faster than the consensus expected and inconsistent with the Federal Reserve’s 2.0% target inflation.

A weakening US economy with inflation remaining (temporarily) stubbornly high would be consistent with the monetary dominance story of inflation’s rise and fall and would also be a problem for the stock market.  Using our Capitalized Profits Model, with a 10-year Treasury yield at about 4.25%, economy-wide corporate profits would need to rise 30%+ to justify an S&P 500 at 5,000.  But there’s no way profits (ex-Fed), which are already high relative to GDP would surge that much higher in a soft economy.  The current consensus puts profit growth at roughly 10% this year.

Time will tell if the weakness in January becomes more widespread.  On the surface, the job market still looks fine, with payrolls up more than 300,000 in both December and January.  But the labor market can be a lagging indicator.

Unprecedented policies during COVID have created noise in the data.  But underneath it all, we still believe Milton Friedman had it right.  A decline in money will lead to recession, and then a decline in inflation.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Posted on Tuesday, February 20, 2024 @ 10:09 AM • Post Link Print this post Printer Friendly
  Housing Starts Declined 14.8% in January to a 1.331 Million Annual Rate
Posted Under: Data Watch • Home Starts • Housing
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Implications:  Home building weakened in January following a healthy end to 2023, with both housing starts and completions dropping sharply.  While the data have been choppy, it had appeared that developers were finally finding their footing in what has been a challenging environment for sales, but January threw things for a loop.  It is possible that colder than normal January temperatures were a factor, as well as unusually high precipitation, but the drop in starts was in every major region of the country and “heating-degree days,” a quantitative measure of national heating requirements when temperatures are below 65 degrees, was not unusually high.  In other words, we see these data potentially signaling broader economic weakness, consistent with the drop in retail sales and decline in manufacturing production in January.  Starts in January were the second lowest for any month since mid-2020, during the onset of COVID when lockdowns still prevailed in much of the country.  Starts fell 14.8% in January, the largest single-month decline since April of 2020.  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 22.0% while multi-unit starts are down 36.8%.  Building permits also fell short of consensus expectations in January, declining 1.5% to a 1.470 million annual rate.  The decline was entirely due to permits for multi-unit homes (down 7.9% in January), as single-family permits rose 1.6%.  While multi-unit permits have been trending down over the past year, permits for single-family homes have increased in each of the last twelve months.  Meanwhile, housing completions fell in January to a 1.416 million annual rate.  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.  As the Fed eventually begins to cut rates, mortgage rates should trend lower as well, helping support housing later in 2024.  

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Posted on Friday, February 16, 2024 @ 10:56 AM • Post Link Print this post Printer Friendly
  The Producer Price Index (PPI) Rose 0.3% in January
Posted Under: Data Watch • Government • PPI • Fed Reserve
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Implications:   Following in the footsteps of Tuesday’s CPI report, producer prices came in hotter than anticipated, complicating the Fed’s path forward.  While headline prices rose 0.3% in January, the inflation was limited by continued declines in energy prices, which fell 1.7% in January following a massive 31.6% annualized decline in the fourth quarter of last year.  Food prices – the other typically volatile category - also declined in January, down 0.3%.  Stripping out these two components shows “core” prices rose 0.5% in January, the largest single month increase since July.  That said, the twelve-month rise in core prices has been easing since peaking at 9.7% back in March of 2022, and now shows core prices up 2.0% from a year ago.  Diving into the details of today’s PPI report shows the dichotomy between goods and services.  Services prices rose 0.6% in January in spite of a drop in costs for transportation and warehousing.  Meanwhile, goods prices declined 0.2%.  However, energy played a central role in the drop in goods prices; strip out energy, and goods prices rose 0.2% in January as prices for communications equipment and soft drinks moved higher.  Further back in the pipeline, processed goods prices fell 0.2% in January and are now down 3.8% in the past year.  Meanwhile unprocessed goods prices rose 0.1% in January but remain down 15.0% in the past year.  Further easing in inflation appears on the way should the Fed have the patience to let tight monetary policy do its work.  But inflation risks rearing its ugly head once again should the Fed falter and overreact in the face of weakening economic data.  The markets - and the Fed itself – seem unsure how soon or how quickly rate cuts will come. We believe patience is a virtue.

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Posted on Friday, February 16, 2024 @ 10:10 AM • Post Link Print this post Printer Friendly
  Three on Thursday - Where is Population Headed?
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This week’s edition of “Three on Thursday” looks at the current state and trajectory of global population. While global population is still growing in absolute numbers, population growth rates peaked decades ago. What lies ahead? Explore further insights by clicking the link below.

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Posted on Thursday, February 15, 2024 @ 12:38 PM • Post Link Print this post Printer Friendly
  Industrial Production Declined 0.1% in January
Posted Under: Data Watch • Government • Housing • Industrial Production - Cap Utilization • Fed Reserve
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Implications:  Industrial production started 2024 off on a weak note, declining 0.1% in January.  Notably, the Federal Reserve highlighted that worse than expected winter weather had big impacts on the January data.  Looking at the details, the manufacturing sector was the biggest weak spot in today’s report, dropping 0.5%, largely driven by non-auto manufacturing, which we think of as a “core” version of industrial production and which fell 0.6%.  Meanwhile, auto production declined 0.1% as well. The brightest manufacturing news in the report was that the production of high-tech equipment rose 1.3% in January and is up 19.8% in the past year, by far the strongest growth of any major category.  This likely reflects investment in AI as well as the reshoring of semiconductor production, which remains temporarily strong due to the CHIPS Act, despite broader weakness in the industrial sector.  The mining sector also fell in January, dropping 2.3%, the largest monthly decline since 2021.  Broad-based weakness in oil and gas extraction, mineral extraction, and the drilling of new wells all contributed.  Finally, the utilities sector (which is volatile and largely dependent on weather), posted a gain of 5.9% in January as unusually cold weather drove a surge in demand for home heating.  In other manufacturing news this morning, the Philadelphia Fed Index, a measure of factory sentiment in that region, rose to +5.2 in February from -10.6 in January. Meanwhile, the Empire State Index, its counterpart for the New York region also rebounded, rising to -2.4 in February from -43.7 in January. Finally in housing news, the NAHB Housing Index, a measure of homebuilder sentiment, rose to 48 in February from 44 in January.  This is the third gain in a row and coincides with the recent moderation in mortgage rates as markets begin to anticipate rate cuts from the Federal Reserve in 2024.  That said, a reading below 50 signals that a greater number of builders view conditions as poor versus good.

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Posted on Thursday, February 15, 2024 @ 12:14 PM • Post Link Print this post Printer Friendly
  Retail Sales Declined 0.8% in January
Posted Under: Data Watch • Employment • Government • Inflation • Markets • Retail Sales • Fed Reserve • Interest Rates
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Implications:  An ugly report on the US consumer today with retail sales declining 0.8% in January, lagging consensus expectations, with nine out of thirteen major categories falling for the month.  Factoring in revisions to prior months, retail sales fell an even larger 1.4%.  The drop in sales in January was led by the volatile auto sector (-1.7%), but stripping this category out does not improve the picture.  Sales excluding autos fell -0.6% and were down an even faster 1.0% when factoring in revisions to prior months.  Other categories to lead the decline in January were building materials (-4.1%) and non-store retailers (-0.8%).  Overall retail sales are up a meager 0.6% in the last year, although that’s also due to a surge in sales in January 2023 that temporarily makes a tough comparison point for the year ago comparison.  Still, it appears consumers are finally running out of excess COVID savings, which were boosted by temporary and artificial government stimulus payments in 2020-21.  Retail sales have fallen in three of the past four months.  While recent data suggest the goods side of the economy may already be in recession, the same cannot be said for the services side.  Sales at restaurants & bars – the only glimpse we get at services in the retail sales report – rose 0.7% in January.  These sales are still up 6.3% in the last twelve months and have yet to show signs of slowing; up at 9.5% and 10.1% annualized rates on three- and six-month timeframes, respectively.  But it’s important to remember that one of the key drivers of overall spending is inflation.  Yes, retail sales are still hovering near record highs unadjusted for inflation, but in “real” (inflation-adjusted) terms, they have been stagnant for nearly two years.  Real retail sales peaked back in April 2022 and have since declined by 3.4% from that peak.  In the last twelve months, real retail sales are down 2.4%.  Our view remains that the tightening in monetary policy since last year will eventually deliver a recession.  Expect more deterioration in real retail sales into 2024 as tighter credit conditions along with higher borrowing costs take their toll.  In employment news this morning, initial claims for jobless benefits declined by 8,000 last week to 212,000, while continuing claims rose by 30,000 to 1.895 million. These figures suggest continued job growth in February.  In other news this morning, trade prices jumped in January, as import and export prices both rose 0.8%. In the past year, import prices are still down 1.3% while export prices are down 2.4%.

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Posted on Thursday, February 15, 2024 @ 11:50 AM • Post Link Print this post Printer Friendly
  The Consumer Price Index (CPI) Rose 0.3% in January
Posted Under: CPI • Data Watch • Government • Inflation • Markets • Fed Reserve • Interest Rates • Bonds • Stocks
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Implications:   Inflation accelerated at the start of the year, showing that it is still an important problem and the Federal Reserve should not rush into cutting rates.  Yes, the M2 measure of money is down in the past year, but that aggregate may not be directly comparable to history and, even if so, the lags are long and variable.  Consumer prices rose 0.3% in January, the most in four months and above the consensus expected 0.2%.  In the past year, overall consumer prices are up 3.1%, still a far cry from the Fed’s 2.0% target.  Notably, headline inflation was held down in January by the volatile energy sector, where prices declined 0.9% in large part due to a 3.3% drop in gasoline prices.  Stripping this category out along with food prices shows that “core” inflation accelerated in January as well, increasing 0.4% – the fastest rate in nine months – while the twelve-month comparison remained stubbornly at 3.9%.  Looking at the details, rental inflation – both for actual tenants and the imputed rental value of owner-occupied homes – continue to defy predictions of imminent reversal, rising 0.5% for the month and still running at or above a 5% annualized rate over three-, six-, and twelve-month timeframes.  This is important because housing rents make up a third of the overall index and accounted for more than half of the monthly rise in January.  But the most troublesome piece of today’s report came from movement in a subset category of prices that the Fed is watching closely – known as the “Super Core” – which excludes food, energy, other goods, and housing rents, and is a useful gauge of inflation in the services sector.  That measure jumped 0.8% in January – the biggest increase since April 2022 – when the US was experiencing the height of its inflation scare.  In the last twelve months, this measure is up 4.4% and has been accelerating as of late (up at 6.7% and 5.5% annualized rates in the last three and six months, respectively), stoking fear that inflation has become entrenched in the services sector.  The spike in Super Core prices in January was largely due to increasing prices for transportation services (+1.0%), medical services (+0.7%), and hotels/motels (+2.4%).  Meanwhile, the US economy and labor market continue to chug along.  No matter which way you cut it, the Federal Reserve has little reason at this point to start cutting rates anytime soon.  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 Tuesday, February 13, 2024 @ 11:31 AM • Post Link Print this post Printer Friendly

These posts were prepared by First Trust Advisors L.P., and reflect the current opinion of the authors. They are based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.
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