Implications:  The trade deficit in goods and services came in at $67.4 billion in December, as imports rose while exports declined. We like to focus on the total volume of trade (imports plus exports), which signals how much businesses and consumers interact across the US border. That measure grew by $2.0 billion in December, but was down 2.5% in the fourth quarter on the back of a 1.1% decline in the third quarter. The total volume of trade is still up 4.4% versus a year ago but continues to show signs of slowing.  Unfortunately, the increase in the past year is driven not only by more goods and services, but also higher prices.  Note that Russia’s invasion of Ukraine and the easing of COVID restrictions in China may affect trade patterns for some time. The good news is that supply-chain problems have improved dramatically.  For example, Captain Kip, the Executive Director of Marine Exchange of Southern California, declared the container ship backup ended on November 22nd .  It took twenty-five months, but things are finally back to normal at the Ports of LA and Long Beach.  In some cases waits have just shifted to other ports, but daily freight rates are also falling rapidly as demand has also weakened. A large part of this is due to a collapse in manufacturing orders in China.  In the months to come, China manufacturing will be buffeted by the easing of COVID restrictions (good!) and a temporary spike of COVID cases (bad!), as the country suffers through cases postponed by overly strict measures in the past couple of years.  If we believed the headlines about a decoupling, we would expect to see “less” trade with China, but trade in goods between our two nations hit a record high in 2022!  Also notable in today’s report, the dollar value of US petroleum exports exceeded imports again.  For 2022 US petroleum exports exceeded imports in nine of twelve months.  For the full calendar year of 2022, the US became a net exporter again of petroleum products. What this means is much of the release from the Strategic Petroleum Reserve just flowed overseas.

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At the beginning of the season, not many predicted that the Philadelphia Eagles would be in the Super Bowl this year.  But, they had a fantastic season and are favored over the Kansas City Chiefs.  Predicting this economy is equally hard.  Anyone who thinks they know exactly how things will turn out is fooling themselves.  COVID policies – lockdowns, massive borrowing, and money printing to pay people not to work – have never been tried before.  So, what happens is still up in the air.

It seems like just yesterday that ZeroHedge – with help from the Philadelphia Fed – was trying to convince people that job growth was non-existent in the second quarter of 2022.  Never mind the fact that they purposefully conflated two different measures of jobs…it just wasn’t true.

So, it must have come as a shock to those who believed that nonsense that in January, after the equivalent of 17 quarter-point Fed rate hikes, jobs data and hours worked exploded to the upside.  Nonfarm payrolls rose 517,000 jobs, while revisions to prior months added an additional 71,000.

Not one economics group came even remotely close to getting this number right.  And the print was especially surprising after seeing retail sales fall 4.3% and industrial production fall 5.2%, at three-month annualized rates, through December.

The difficulty of forecasting in this environment is absolutely astounding.  On the one hand, the M2 measure of money has contracted in the most recent twelve months (the first time in more than sixty years), after growing over 40% in a two-year timespan.  On the other hand, even with the Federal Reserve’s sharp rate hikes, the federal funds rate is still below inflation.

Using M2 growth, alone, and Milton Friedman’s lag of 6-9 months, we should be seeing the economy begin to slow, which is what retail sales, industrial production, housing, and retail auto sales have been pointing to.  And so far with 256 out of the S&P 500 companies having reported, profits are down 3.1% from a year ago.

But it’s not just M2…the rebound from COVID lockdowns is over.  Stores are back open, airplanes packed, and hotels filled.  Now that we are back to “normal”, how much further can things go?  We aren’t going to have two packed-stadium Super Bowls this year, just one.  And pandemic unemployment checks and PPP loans have run their course.  Yes, some state and local governments, and school districts, have money left, but not much.  To our way of thinking, we should see a slump now that the drugs of all the borrowing wear off.

So, how then did jobs provide such a large upside surprise!?!  Do employers really know what they are doing?  Do they see something that is not showing up in the data?  Or is this a delayed reaction (after all, employment is a lagging indicator) to issues with hiring during and after the pandemic.

If you couldn’t hire workers, but now they want to work, and you expect a soft landing (or even no recession at all) then you grab all the workers you can, when you can.  But if there is a “hard landing” profits could be squeezed even more.

Taking all this into consideration, we don’t think the boom in nonfarm payrolls is a signal worth following.  Many companies…Peloton, Bed, Bath & Beyond, Hasbro, and lots of tech stalwarts were winners when services were locked down and people with fresh stimulus funds needed tech.  But now they are all in either financial trouble or are laying off workers.  The losers during the lockdowns (services) have all reopened, but people aren’t going to double their use of services, especially with interest rates up and money supply down.

So, while one number from one month seemed to change a lot of people’s minds about the economy, we think we’re far from the final whistle of the game.  This one isn’t over yet.

Unprecedented actions on the scale that we experienced in 2020-2022 will bring unexpected results in 2023.  So, while we never want to ignore a number like the January jobs report, we have to question how much is signal and how much is noise.

The economy is still absorbing the money printed during the pandemic.  Inflation has not been eradicated, the Fed is highly unlikely to loosen policy anytime soon, and earnings are likely to fall as all the stimulus wears off.  That’s not a recipe for a simple forecast or a soft landing.  Like the Super Bowl, until the game is played no one knows exactly what will happen.  Count us less bullish than conventional wisdom.

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. 

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Implications:  The ISM Services index surprised sharply to the upside for January, rebounding from contraction territory (below 50) in December by posting the largest monthly increase (besides the COVID reopening month) since records began in 1997.  The rise was driven by new orders and business activity, which both surged to 60.4.  Meanwhile, the categories for employment and supplier deliveries both rose to 50.0, signaling no change in jobs or production bottlenecks.  Respondent comments in January were largely positive, citing strong demand and a cautiously optimistic growth outlook for 2023.  Finally, the prices paid index ticked down to a still very elevated 67.8.  While that is well below its peak from early 2022 – make no mistake – inflation is still a major problem in the service sector, with fifteen out of eighteen industries reporting paying higher prices.  We expect the service sector to keep inflation trending well above the Fed’s 2.0% target for some time.  Comparing the two January ISM reports, it’s clear that businesses and consumers are shifting resources away from goods and toward the service sector.  While the service sector does not appear to be there yet, we believe the US economy will enter a recession in 2023.  A handful of reports like industrial production, retail sales, and M2 suggest we could be already there, although today’s reports muddy that picture.  We continue to think equity investors should be cautious.  One thing we are certain about; there is no such thing as a free lunch.  Eventually, the bill for the massive artificial stimulus in 2020-21 will come due.  

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Implications:  If you weren’t confused by the economy already, today’s jobs data should have twisted your thinking into knots. In spite of the fact that retail sales have fallen for two months in a row, and the markets have seemingly priced in a “soft landing,” nonfarm payrolls rose 517,000 in January (plus 71,000 for prior months), easily beating the consensus expected 188,000.  Meanwhile, the unemployment rate ticked down to 3.4%, tying the lowest level since the early 1950s.  If you believe tight labor markets cause inflation (we don’t, but the Fed does) this is a reason to keep tightening monetary policy.  Don’t expect the Fed to swallow its pride and go back to raising rates by 50 basis points in March, but investors should expect the Fed to raise rates by more than the futures market now expects and keep rates at higher levels for longer.  The most impressive indicator for January was total hours worked, which surged 1.2%, more than offsetting modest declines in November and December.  Yes, average hourly earnings rose a moderate 0.3% for the month, but the two sectors with the greatest payroll gains were leisure & hospitality and education & health services, which tend to have below-average earnings.  An alternative measure of jobs (household employment) that includes small-business start-ups, increased 894,000 in January.  But this incorporates new estimates of the US population and that change alone accounted for 810,000 of the gain in civilian employment.  Add in the fact that the labor market is often a lagging indicator and it may be even more so now because this is the first time in more than twenty years that businesses face heightened recession risk due to tighter monetary policy (rather than mark-to-market rules or COVID lockdowns).  Industrial production and retail sales are getting weaker, not stronger.  As a result, we think many companies are getting out over their skis, continuing to hire in anticipation of business activity that, when it doesn’t materialize, will eventually force them to cut payrolls substantially.  Mixed with a monetary policy that is now likely to get and remain tighter than the market anticipates, we continue to think equity investors should be cautious.  COVID policies were unprecedented – so, we shouldn’t be surprised that the data are very volatile.

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Implications:  Nonfarm productivity rose in the fourth quarter, increasing at a 3% annualized rate, as output rose at a quicker pace than hours worked, leading to more output per hour. Still, productivity is down 1.5% from a year ago, and for the calendar year of 2022, was down 1.3% versus 2021, the largest annual decline since 1974.  Even though inflation is still high, “real” (inflation-adjusted) compensation per hour grew at a 1.0% annualized rate in Q4, the first positive reading of the year.  However, inflation still remains a key headwind for workers’ purchasing power as “real” compensation is down 3.8% from a year ago. This will be an ongoing issue in the coming quarters, as inflation stays stubbornly elevated.  On the manufacturing front, productivity declined at a 1.5% annualized rate as both output and hours fell, but output fell at a faster pace. This, along with other manufacturing data we have received over the past few months, shows that manufacturing has slowed and is likely in a recession already. Expect hours and output to continue to weaken in the quarters ahead. In other news this morning, on the employment front, initial jobless claims fell 3,000 last week to 183,000. Meanwhile, continuing claims for regular benefits fell 11,000 to 1.655 million. These numbers point to continued gains in jobs in tomorrow’s employment report.  We’re estimating a nonfarm payroll gain of 185,000 with the unemployment rate increasing to 3.6%. Also earlier this week, cars and light trucks were sold at a 15.7 million annual rate in January, up 17.7% from December and 4.1% from a year ago. Don’t get too excited about this increase, though. Fleet sales to corporate purchases (think car rental companies) were the reason for the surge in January but are very unlikely to be repeated in the months ahead.

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The Fed downshifted to a smaller rate hike to start 2023, but the job is far from done. As expected, the Fed raised rates by 25 basis points (bp) today, slowing from the 50bp hike in December, and the 75bp hikes at the four meetings before that. However, the Fed continued to reiterate that ongoing tightening is warranted and repeated the view that the risk to doing too little is greater than the risk of doing too much.

While we have to wait for March to get updated forecasts from the Fed (the dot plots), there were a number of changes to the Fed statement and Powell had plenty to talk about during his press conference.  

If you only saw today’s statement announcing the Fed’s move, the primary takeaway would be a shift toward a more dovish tone. Instead of focusing on the factors causing inflation to stay elevated, the Fed introduced new text that inflation pressures have started to ease.  And gone is commentary about the ongoing Russian/Ukraine conflict contributing to inflationary pressures, which is now replaced with a note that the conflict is keeping global uncertainty elevated.  Finally, with the size of today’s rate hike down to 25bp, text was changed to shift the attention from the pace of hikes to the extent of future hikes.    In other words, the Fed’s focus is now on finding the finish line.

Then the press conference started.  Chair Powell started dovish stating that it is “gratifying” to see disinflation starting to show in the data, and acknowledging that softening in wage pressures is a positive sign for future inflation, but he then tempered those remarks by reinforcing his belief that there is more work to be done. What has the Fed concerned is that non-housing service inflation remains unusually high.  Until this metric turns, the Fed will not feel comfortable claiming victory and backing off. 

Nick Timiraos – the Wall Street Journal’s Fed reporter who many watch as an unofficial mouthpiece for Powell and Co. – asked the question that many have been thinking. Can the Fed  simply pause at the current level of rates and watch to see how that flows through to inflation prints in the months ahead? Powell responded by saying the Fed thinks the greatest risk – and the most difficult situation for the Fed to manage – is in not doing enough and seeing inflation reaccelerate.  If the Fed overshoots on tightening and inflation comes down faster and further than anticipated, the Fed has far more tools available to ease policy.  Victory over inflation is priority #1. 

It’s good the Fed has prioritized the fight against inflation, but the necessary path to get there will likely bring volatility to the financial markets.  While markets have rallied to start the year, we expect the party to end once they realize how much the economy will slow due to the decline in the M2 measure of the money supply since early last year. That economic medicine, while bitter, is part of the price we pay for the policy mistakes in 2020-21.  And we are still amazed at how little attention the Fed and journalists give the money supply.        

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist 

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Implications:   The US manufacturing sector fell further into contraction territory in December with only two of eighteen industries reporting growth.  Respondent comments in January showed customers pulling back on purchases of manufactured goods as well as improvements in the supply-chain issues that have plagued the factory sector over the past few years.  Given that consumers have been shifting their preferences away from goods and back toward services, it wasn’t surprising to see the new orders index decline for a third consecutive month in January.  However, worries about the future have now caused factories to slow down the pace of production, with that index declining further in January. However, there was some good news in today’s report. Though the employment index also declined modestly in January, it remained in expansion territory. Surprisingly, panelist sentiment shifted sharply in January with a majority saying they are looking to hire rather than reduce headcount.  Part of this may be the recent weakening in the US dollar which could be spurring a rebound in export orders. Meanwhile, data on supply-chain pressures continue to look reassuring.  For example, though the supplier deliveries index rose slightly to 45.6 in January, that was still the second lowest reading since 2009!  When this index is below 50, it means deliveries are speeding up.  Finally, though the prices index in today’s report rose for the first time in ten months it still remains in contraction territory. While lower prices for some goods will help moderate overall inflation, we expect the services sector will now be the main driver going forward, keeping inflation well above the Fed’s 2% target. In labor market news this morning, the ADP employment report showed a gain of 106,000 private-sector jobs in January, well below the consensus estimate of 180,000.  After plugging today's numbers into our model, we expect Friday’s employment report to show a nonfarm payroll gain of 185,000.  We also got data on construction, which showed that spending declined 0.4% in December, with large declines in residential and manufacturing projects more than offsetting gains in roads. In other recent news, national average home prices continued to trend downward in November, with the Case-Shiller index declining 0.3% and the FHFA index, which tracks homes financed by conforming mortgages, slipping 0.1%.  Although both indexes are still up about 8% from a year ago, they are also both down from the June 2022 peak, with the Case-Shiller down 2.5% and the FHFA down 1%.  Expect further home price declines until at least late this year.  In the past three months, prices are down the most in Las Vegas, Phoenix, and San Francisco.  

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The US federal budget is on an unsustainable path…but not for the reasons that most people think.

Yes, the national debt is $31 trillion, well higher than annual GDP, and only going higher.  Yes, the budget deficit last year was more than a $1 trillion for the third year in a row.  None of this is good.

But the real root of the fiscal problem, and our biggest concern, isn’t the debt or the deficits, it’s government overspending.  If the government had an enormous debt, but spent little, the private sector could produce the country’s way out of the debt problem.  And if the US had little debt, we could still have economic problems from too much government spending.  Ultimately, the government funds itself by borrowing or taxing the wealth produced by private industry.  If spending were high and borrowing low, taxes would have to be prohibitively high.  The bottom line is that excessive spending leads to economic ills.

According to the CBO, spending on entitlements like Social Security, Medicare, Medicaid, and other health care programs will rise from 10.7% of GDP to 15.1% in the next thirty years.  Meanwhile, the net interest on the national debt will almost certainly be higher than it was last year, unless and until we bring the deficit down and slow the growth in debt.

This is why the debt limit debate now going on in Washington, DC is so important.  Don’t fall for the false narrative that one group of politicians wants to push the country into default.  Nor, should anyone want to abolish the debt ceiling altogether.  If there is a way to shine some light on overspending, why shouldn’t it be used?  If debt ceiling politics can focus attention on fiscal issues, it’s done its job.

What we expect is a last-minute budget deal that includes either caps on discretionary spending for future years, some sort of commission or committee that can make proposals to reform entitlements (with expedited procedural rules so the proposals get a congressional vote), or both, as part of a bipartisan deal to raise the debt ceiling.

But let’s go down the highly unlikely path that the debt limit isn’t raised.  The Treasury Department would still have enough cash flow to pay all securitized debt as it came due, as well as entitlements such as Social Security, Medicare, and Medicaid.  It’s true that other programs and agencies would have to take substantial cuts to make sure those higher priority payments get made; and yes, the Biden Administration will not enjoy making that choice.  But it’s still a choice that they alone get to make.

Ultimately, investors and voters need to realize that not every national debt is the same, even if they’re the same amount.  The US had a debt problem after the Revolutionary War, which was a small price to pay for starting an independent country.  We had a debt problem after World War II, but that was a price we paid to win a crucial war.   Our current debt problem is not like those.  In too many cases, politicians spend to win favor with constituents.  It’s not wrong to use the debt ceiling as a way to focus attention on this problem and the endemic overspending that it creates. That’s a habit this debt limit debate needs to break.   

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