Implications:  New home sales remained choppy, posting a widely expected decline as the housing market tries to digest the recent rise in mortgage rates.  Sales have generally been on an upward trend in the past year and are now 24.3% above the low in July of 2022.  However, they still remain well below the pandemic highs of 2020. The main issue with the US housing market remains affordability.  Assuming a 20% down payment, the rise in mortgage rates since the Federal Reserve began its current tightening cycle amounts to a 30% increase in monthly payments on a new 30-year mortgage for the median new home.  With 30-year mortgage rates currently sitting above 7.5% for the first time in two decades, financing costs remain a headwind.  The good news for potential buyers is that the median sales price of new homes has fallen by 13.4% from the peak late last year, which had, until recently, helped sales activity recover.  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. For example, the supply of completed single-family homes is up 150% 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 help put a floor under sales activity.  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 homebuyers will eventually adjust.  In other news on home prices this morning, the national Case Shiller index and the FHFA index rose 0.6% and 0.8%, respectively, in July.  Notably, both indices now show home prices at a new all-time high.  In recent manufacturing news, the Richmond Fed index, a measure of mid-Atlantic factory activity, rebounded to +5.0 in September from -7.0 in August.

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We have plenty of data reports to go, but, so far, the third quarter is shaping up to be a strong one for the US economy.  The Atlanta Fed’s GDP Now model is tracking a Real GDP growth rate of 4.9% for Q3, which would be the fastest quarterly growth rate since the earlier part of the COVID recovery.

Our models aren’t tracking quite so high but are projecting growth at about a 4.0% rate, still strong by the standards of the past couple of decades.

However, we would not get too excited about what’s happening in the third quarter and don’t think one quarter of strong economic growth means a recession is off the table.

With all the oddities of the COVID era – first overly strict lockdowns and then overly gradual re-openings – it’s entirely possible the GDP reports are exhibiting some “seasonality,” where certain quarters look better than the underlying economy really is.  The third quarter is when children typically go back to school, for example, but, unfortunately, they did that less so during COVID.  As a result, normal back-to-school behaviors might make the economy look extra strong for now.

To put some numbers on this, statistical adjustments to retail sales (called seasonal adjustments) subtracted 1.8% from reported sales in July 2019, prior to pandemic shutdowns.  Back to school spending in July (much like Christmas) makes for some big spending months, and the statisticians adjust the numbers down.  But in 2020, 2021 and 2022 July sales fell because so many schools were closed.  This reversed the seasonals and this July (2023) seasonal adjustments added 1.4% to reported sales.  We think this is distorting our view of the economy.

Meanwhile, the economy is likely feeling the last positive remnants of the surge in the money supply in 2020-21.  The lags between monetary policy and the economy have always been long and variable, as Milton Friedman taught us.  Beyond the third quarter, the economy is likely to show more of the effects of the drop in the M2 measure of the money supply from mid-2022 through early 2023.

Another reason we think the third quarter is a head-fake is that deficit spending by the federal government is very unlikely to expand in 2024 like it has in 2023. Were it not for President Biden announcing his student loan debt forgiveness plan last year the budget deficit would have been 4.0% of GDP in Fiscal Year 2022, high but not extraordinary.

And if it hadn’t been for the Supreme Court striking down that plan this year, the deficit would have been about 7.8% of GDP for Fiscal Year 2023, well beyond even the highest deficit under President Reagan in the 1980s and all while the unemployment rate is averaging about 3.6%.

The rise in the deficit of almost four percentage points of GDP with the unemployment rate so low is unprecedented.  Other prior leaps in the deficit of this magnitude have been during major wars or recessions, not when the US is at peace and the unemployment rate is unusually low.

In particular, the way some of the extra deficit spending is structured looks designed to temporarily and artificially boost economic growth.  The CHIPS Act, for example, is encouraging private investment in chip manufacturing facilities in the US.  So far this year (through July), private spending to construct manufacturing facilities in the computer, electronic, and electrical sector are up 228% versus the same period in 2022.

But these buildings don’t have to be rebuilt every year.  Sometime soon the gains in this sector will dwindle and reverse, with collateral damage to other sectors, like trucking.

To be clear, we do not believe government spending is a positive for long-term growth.  In fact, it often distorts and diminishes overall activity.  However, in the short-term, as we saw during COVID (and apparently this year as well) it can make the economy look stronger than it really is.  A price will be paid, and as all this extra stimulus wears off a recession is highly likely.  We don’t see how it is avoided.

The next recession is unlikely to be as devasting as the ones in 2008-09 or 2020.  But our view remains that a recession is on the way.       

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist 

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We live in unprecedented times. Since the COVID pandemic, the economy has been deeply influenced by a massive increase in government spending, COVID-related shutdowns, and a huge increase in the money supply.  In all our years of economic forecasting, the task of identifying where we are and where we are heading has never been so difficult.  Now more than ever, it is important to follow real-time data on the economy. The charts in the High Frequency Data Tracker follow data that are published either weekly or daily, providing a check on the health of the US economy. 

Click here to view the report

Implications:  There wasn’t much to get excited about in today’s report on existing home sales, which fell for a third consecutive month in August.  The housing market facing a series of headwinds, some of them temporary.  First, the recent surge in benchmark interest rates like the 10-year Treasury yield has translated into 30-year fixed mortgage rates as well, which are currently hovering above 7.5% for the first time in more than two decades. 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 41% 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 each surge in rates, like we’ve experienced lately, leads to some indigestion.  Meanwhile, home prices appear to be rising again, although modestly, with the median price of an existing home up 3.9% from a year ago.  In addition, many existing homeowners are reluctant to sell due to a “mortgage lock-in” phenomenon, after buying or refinancing at much lower rates before 2022.  That should limit future existing sales (and inventories).  However, a tight inventory of existing homes should prevent a repeat of 2008.  Case in point, the months’ supply of homes (how long it would take to sell existing inventory at the current very slow sales pace) was 3.3 in August, well below the benchmark of 5.0 that the National Association of Realtors uses to denote a normal market.  Finally, a weakening economy in which the Federal Reserve doesn’t act quickly to cut rates, because of high inflation, could be a headwind for home sales next year.  Adding this altogether, expect sales and prices to drag on in the year ahead, with no persistent recovery in existing home sales until at least late 2023 or early 2024.  In employment news this morning, initial claims for jobless benefits fell 20,000 last week to 201,000.  Meanwhile, continuing claims fell 21,000 to 1.662 million. These figures suggest continued growth in employment in September.  Finally on the factory front, the Philadelphia Fed Index, which measures manufacturing sentiment in that region, fell to -13.5 in September from +12.0 in August.  The region is home to auto-parts manufacturers who are likely affected by the UAW strike.

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For our inaugural edition of Three on Thursday, let’s take a closer look at the housing market. Housing prices are up significantly from early 2020 levels, while mortgage rates are now hovering near 7.5%, the highest in more than two decades. Does this mean we should brace ourselves for another 2000’s-esque housing crisis?  Our assessment of the data suggests otherwise. 

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While the Fed kept rates unchanged at today’s meeting, between the press conference and forecast updates, Powell and Co. gave plenty of ammo to keep the financial press busy speculating about what may come at the next FOMC meeting this Fall.  

Today’s Fed statement itself was a non-event, with minor wording changes noting that the economy is growing at a “solid” rather than “moderate” rate, and employment gains have “slowed” but “remain strong”. It’s in the updated economic projections (the “dot plots”) – which give a peek at how the Fed expects the economic and rate landscape to evolve moving forward – that things got interesting.  

The Fed upped its economic growth forecasts for this year and next to 2.1% and 1.5%, respectively, compared to June estimates of 1.0% and 1.1%.  Along with stronger growth, the Fed projects a more modest rise in the unemployment rate to 3.8% (prior forecast of 4.1%) and slightly higher inflation of 3.3% (prior forecast of 3.2%).  Interestingly, they lowered their forecasts for “core” inflation – which strips out the volatile food and energy components – to 3.7% for year-end 2023, and they have core inflation sitting at 2.6% by the end of 2024.  We would take the over on that bet.  

What do these outlook changes mean for the path of rates? One more rate hike is anticipated by the majority of policymakers before the end of the year, just as they forecasted in June, but they now believe that rates will then need to remain higher for longer.  June projections showed a total of one hundred basis points (bps) of rate cuts anticipated by FOMC members in 2024, but that has now been revised to expected cuts of 50 bps. On balance the dot plots showed a more hawkish outlook. 

During the press conference, questions revolved around how the Fed will determine if/when rates have become sufficiently restrictive and no further hikes are expected.  Powell here channeled former Supreme Court Justice Potter Stewart’s classic line that he will “know it when he sees it.”  In other words, the Fed does not have a high degree of confidence on when exactly the rate hike/cut process will be accomplished. They – by their own admission – have had a very difficult time forecasting how inflation and rates would unfold, and their models still aren’t up to the task. 

What makes this so frustrating is that the Fed – and the financial media who have the opportunity to ask questions during the Q&A session – refuse to even discuss the impacts of the money supply on the inflation ills of the past few years.  If the Federal Reserve were paying close attention to the money supply, it would know that monetary policy is already tight.  While M2 has risen modestly since April following nine-consecutive months of decline, the money supply has contracted 3.7% in the past year.  Meanwhile, bank credit at commercial banks as well as their commercial and industrial loans are both down.  If this isn’t tight, we’re not sure what tight means.

It remains to be seen how quickly the reductions in the money supply will translate into inflation getting back to the Fed’s 2.0% target, but the Fed has gained some traction against the inflation problem.  Given time, the mission can be accomplished, but the Fed must remain patient. They waited far too long to start rate hikes; they shouldn’t jump the gun on cuts.

For now, each FOMC meeting should be considered “active,” meaning the Fed is ready to raise rates further if the data suggests more work to be done. But without a clear path forward the looming government shutdown, resumption of student loan payments, slowing employment growth, and higher oil prices could cloud the Fed’s vision as 2023 comes to a close.  Where’s the finish line? Nobody knows for sure, but we aren’t there yet.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications:  Housing starts posted the largest monthly decline in over a year in August, falling to the slowest pace since the worst of the COVID pandemic in 2020.  However, we don’t see this as a sign of persistent weakness ahead in home building.  While both single-family and multi-unit projects contributed to the decline, a massive 26.3% drop in the multi-unit category was largely responsible for today’s bad headline number.  Looking at the big picture, during COVID, a combination of extremely low interest rates and pressure to work from home led initially to big migration to the suburbs and high demand for single-family homes.  Then the economy reopened, causing many people to flock back to cities, sparking a boom in apartment projects.  Currently, the number of multi-unit properties under construction is hovering near record levels going back to 1970 when records began. Now it looks like the move back to the cities has petered out leaving a glut of apartments.  In contrast, owners of existing homes are hesitant to list their properties and give up fixed sub-3% mortgage rates, so many prospective buyers have turned to new builds as their best option.  This has created a huge gap in the data, with construction of single-family homes up a modest 2.4% in the past year while multi-unit activity is down 41.6% over the same period.  In other words, home building isn’t falling off a cliff like in the prior housing bust.   Home completions rose 5.3% in August and permits for both single-family and multi-unit properties posted gains. In other recent housing news, the NAHB Housing Index, a measure of homebuilder sentiment, fell to 45 in September from 50 in August.  This is the second decline in eight months and coincides with a recent jump in mortgage rates. An index reading below 50 signals that a greater number of builders view conditions as poor versus good.

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The University of Colorado Buffaloes are undefeated and suck up a lot of oxygen in the college football world.  After just three games as the new head coach, Deion Sanders was interviewed by 60 Minutes.  For now, the Buffs have gone from irrelevant to essential in the college football world.  In the competitive arena of sports or business you need to stand out to be noticed.  But, when you’re the government, standing out isn’t hard to do.

This week, the Federal Reserve is set to release a new statement on monetary policy.  And, by the end of this month, Congress is supposed to either pass a new budget or possibly shutdown non-essential government services.  Investors will be watching intently.

We don’t think the Fed will provide many surprises.  As of the Friday close, the futures market was putting the odds of a rate hike at this week’s meeting at less than 1%.  That may be too low, but the Fed won’t surprise on this front.  It will release a new batch of economic forecasts as well as “dot plots” that show where policymakers see short-term interest rates heading.

This could be the surprise: The futures market’s odds of a rate hike by the December meeting are roughly 45% and we think that’s too low.  Oil prices are lifting inflation once again, and rising health insurance rates will keep inflation elevated later this year.  Meanwhile, real GDP growth looks solid in Q3.  Mixing stubbornly high inflation with solid economic growth is not a recipe for a prolonged pause by the Fed, at least not yet.

We think the Powell presser and the dot plots will make it clear the Fed is leaning toward one more rate hike before the year is through.  Our greatest hope is that someone asks Powell about the money supply and he acknowledges its importance for conducting monetary policy, but if that happens we’d be (happily) surprised.

Instead, we expect to hear at least one question for Powell about the looming possibility of a government shutdown at the end of September.  The media and investors are starting to focus on this issue.  We don’t think this is time well spent.  History shows no relationship between federal shutdowns and the performance of the economy.

We had two shutdowns in late 1995 and early 1996, and saw no recession either time.  There was a shutdown in 2013, no recession.  There was a brief shutdown early in 2018, no recession.  The most recent shutdown was the longest, thirty-five days from December 2018 through January 2019.  You guessed it, no recession.  The last time a shutdown coincided with a recession was in October 1990.  That was only a four-day shutdown, but money was already tight and a recession was inevitable either way.

Here's another way to think about it: In the last forty years, the government has been shut for 91 days.  Among those days, the US was in recession for four days and not in recession for eighty-seven.  By contrast in the past forty years the US has been in recession about 8% of the time.  That means the economy was more likely to be growing when the federal government was shut than when it was open!

This doesn’t mean a recession can’t start in the fourth quarter.  But if we do get a recession it’ll be a coincidence, due to the lagged effects of the tighter monetary policy of the last year, not a shutdown itself.

Note that unlike some other budget confrontations in the past, this one does not involve paying the federal debt.  For better or worse the debt limit has been suspended until January 2025.  This means that even if the government is shut all the debt will get paid on time; there will be no default.

Social Security checks and other benefit payments will still go out. The mail still gets delivered.  Essential government workers keep working, including those needed for national defense.  The government is not the economy, even though many in DC (and many voters) think it is.  But, those that produce wealth are the ones who have to pay for it.  And that cost keeps going up.  In 1930, the federal government (without defense) was about 2% of GDP.  Today that percentage is 22%.  The government has grown about 10 times more than the economy as a whole.  Debt is at a record high and, with higher interest rates and rapidly rising entitlement costs, we are on an unsustainable path.

As we said two weeks ago, the federal government is running the most reckless and irresponsible budget in US history.  Even John Maynard Keynes’ would not support such massive deficits with the unemployment rate so low.  This can’t go on now that interest rates have returned to more normal levels.  If a shutdown is the price we pay to start moving in the direction of less government spending, investors should be eager to see that happen.  The shutdowns in the mid-1990s caused the government to become more fiscally responsible and led to Clinton era surpluses.  And that was good for everyone.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

Click here for a PDF version

We live in unprecedented times. Since the COVID pandemic, the economy has been deeply influenced by a massive increase in government spending, COVID-related shutdowns, and a huge increase in the money supply.  In all our years of economic forecasting, the task of identifying where we are and where we are heading has never been so difficult.  Now more than ever, it is important to follow real-time data on the economy. The charts in the High Frequency Data Tracker follow data that are published either weekly or daily, providing a check on the health of the US economy. 

Click here to view the report

Implications:  Industrial production surprised to the upside in August, rising for the second month in a row.  Looking at the details, the strength in today’s report was broad-based with nearly every major category posting a gain.  The largest sub-component, manufacturing activity, rose a tepid 0.1%.  However, that masked some strength beneath the surface.  While output in the volatile auto sector fell 5.0% in August, non-auto manufacturing posted the largest monthly gain since January, rising 0.6%. Meanwhile, the utilities sector (which is volatile and largely dependent on weather) also helped drive the headline gain, posting an increase of 0.9%. Finally, output in the mining sector increased 1.4% in August, also the largest gain since January.  A faster pace of oil and gas extraction more than offset declines in the mining of other commodities and the drilling of new wells.  Given that the mining index remains below its pre-pandemic highs, and the fact that WTI crude prices have recently surged back above $90 a barrel, we expect mining to be a lifeline for industrial production in the near term. In other factory news this morning, the Empire State Index, a measure of New York factory sentiment, jumped to +1.9 in September from -19.0 in August.  Also today, import prices rose 0.5% in August while export prices increased 1.3%.  In the past year, import prices are down 3.0% while export prices are down 5.5%.

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