Implications: Activity in the manufacturing sector beat expectations in July and accelerated to the fastest pace in more than four years. The 55.6 level registered in July is now the seventh consecutive month of expansion for the ISM Manufacturing index, an encouraging development for an industry that has faced significant challenges in recent years.  While we remain cautious for the broader economy, it's clear that AI-related capital investment, the reshoring of production, and increased defense procurement are providing meaningful support to the industry.  Looking at the details of the report, fifteen out of the eighteen major manufacturing industries reported growth in July, with only one industry reporting contraction (Chemical Products), and two reporting no change. All of the major measures of activity increased for the month, led by a jump in the production index to 58.5 from 52.2, the highest since 2021.  Survey comments report booming demand for semiconductor end products and connectivity (power, networking, and photonics) as well as defense, while order volumes for medical, industrial, and consumer products are markedly lower. It is important to remember that until this year, new orders had been very weak going back to 2023, leaving manufacturers focused on order backlogs to keep production going.  So it’s great to see that along with the rise in new orders (currently sitting at 56.7), order backlogs have grown each month in 2026 after more than three straight years in contraction, now sitting at 55.5, signaling solid expansion.  The best news in the report is that the recent improvement in demand has finally enticed manufacturers to boost their hiring efforts, with the employment index increasing from 49.7 to 52.2, the first time in expansion territory in 34 months. However, of the eighteen major manufacturing categories, an equal number reported employment growth in July (six) versus contraction, suggesting the industry’s employment picture remains uneven. On the inflation front, the prices index moved lower to a still elevated 71.1 in July, below its recent peak of 84.6 back in April, but still significantly higher than the 59.0 level at the beginning of the year.  While we still believe there are problems elsewhere in the economy, certain industries are driving a manufacturing rebound that few expected just a year ago.  In other news this morning, construction spending declined 0.1% in June, as declines in homebuilding and manufacturing projects offset a rise for office and power construction.

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Kevin Warsh became Fed Chair barely ten weeks ago.  He has presided over just two sets of monetary meetings and held two press conferences.  Nonetheless, more than any chairman since at least Alan Greenspan, he has come under harsh criticism by the press right out of the gate.

Long-term interest rates have risen by 20 basis points or more in recent weeks, with the 10-year Treasury now yielding 4.68% and the 30-year at 5.23%.  The popular narrative is that this is all Warsh’s fault because he hasn’t moved quickly to raise short-term rates.  On top of this, Warsh wants the Fed out of the “guidance” business as much as possible.  So, as the theory goes, investors are charging a premium based on potentially higher inflation, or uncertainty, or maybe a little of both.

The press criticism dovetails with the three dissents from Fed policymakers (all Regional Bank Presidents) at the meeting last week in favor of raising short-term rates.

What’s peculiar about the criticism is that it’s coming from quarters that were never as critical about outgoing chairman Jerome Powell, in spite of his presiding over an inflation spike that peaked at 9.0% and did so without the excuse of a war in the Middle East.  Back then, these journalists were OK with the Fed exercising patience and calling it “transitory.”  And they hardly ever spoke ill of 0% interest rates.

Long-term interest rates have moved up lately, but a better explanation than blaming Warsh is that bond-market vigilantes are finally reacting to $39+ trillion in debt and deficits as far as the eye can see.

None of this is to say that a rate hike would be completely unreasonable.  As we wrote two weeks ago, it’s been more than five years since inflation has been at or below the Fed’s 2.0% target.  Warsh has stated clearly that his goal is not 2.0% over time, but 2.0% or less forever.  And with short-term interest rates still below the growth rate of nominal GDP, it’s hard to justify rate cuts at this time.

And what economic journalist wouldn’t want to cover a situation where President Trump’s recently appointed Fed Chair raises rates and then suffers a bombastic response from the White House?  This situation puts us in mind of what happened to former British Prime Minister Liz Truss back in 2022, when after proposing tax cuts, she got the blame for higher bond yields even though the Bank of England raised rates at the same time.  In the end, she was run out of office after only 49 days.

We also can’t casually dismiss the notion that some of the criticism might be related to Warsh’s interest in taking the Fed in a new direction, including a smaller balance sheet.  If you have a vested interest in the status quo, undermining the top official promising change could be an effective strategy.

The shift to “abundant reserves” in 2008 has created a situation where the Fed is now more involved in government finance than ever before.  The US Treasury has roughly $900 billion in its Treasury General Account (TGA) and Secretary Bessent has suggested that it may use that money to enter the repo market.

In other words, as Chair of the Fed, Kevin Warsh is presiding over a more complicated scenario than any Chair since Paul Volcker.  It’s only right to give him time.  We think he is moving in the right direction.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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With the preliminary estimate of Q2 Gross Domestic Product (“GDP”) released this morning, the U.S. economy grew at an annual rate of 1.8% in the first half of 2026, slightly lower than the 2.0% in 2025. In this week’s “Three on Thursday,” we break down what’s driving GDP growth, where the economy is gaining momentum, and where it is beginning to slow. To find out more, click the link below.

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Implications: Both income and consumption rose in June after surging in May, while prices fell for the first time since 2022.  Starting with income, growth was led by private sector wages and salaries which rose 0.2% (up 4.7% in the past year) and government transfer payments which were up 0.5% in June (+4.3% from a year ago).  While the 4.7% increase in private sector wages over the past year sounds decent on paper, remember that inflation is up 3.7% over the same time period, meaning purchasing power is little changed.  On the spending side, personal consumption rose 0.3% in June, led by health care, motor vehicles, and financial services.  Collectively, goods spending (which includes energy costs) rose a modest 0.1% in June, while spending on services increased 0.4%.  The personal saving rate — which tracks how much of after-tax income is not consumed — fell to 2.7% in June, marking the lowest reading since the COVID-era in 2022 (and before that during the Great Financial Crisis in 2008!).  This low level of saving allows for more spending today, but isn’t sustainable long-term.  Meanwhile, the inflation picture eased temporarily as the conflict with Iran was on pause and oil prices eased. PCE prices – the Fed’s preferred inflation metric – fell 0.1% in June, while the year-ago reading moderated to 3.7%.  “Core” prices, which strip out the volatile food and energy categories, rose 0.1% in June, with the year-ago comparison now at 3.3%, a notable uptick from the 2.8% pace for the twelve-months ending in June 2025.  The Fed will be watching these data closely under their new Fed Chair, while trying to determine how monetary policy – which operates with a lag – should respond as inflation continues to ebb and flow.  We expect the Fed will remain on pause for the foreseeable future as they wait for the fog to clear and a better picture of sustained inflation pressures to come into view.  In recent housing news, the FHFA index rose 0.3% in May and is up 2.2% in the past year, while the national Case-Shiller index was unchanged in May, but is up 1.1% in the past year. In other news, the Richmond Fed index, a measure of mid-Atlantic factory activity, ticked up to 5 in July from 4 in June.

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Implications: Economic growth was mediocre in the second quarter, with inflation running hot due to the Iran War.  Real GDP grew at a 1.5% annual rate in Q2, lagging the consensus expected 2.0% as well as the 2.1% growth rate in Q1.  Personal spending, which grew at a 3.2% rate, was the key driver for economic growth in the second quarter.  However, the AI/data center build-out also remains a very important factor.  Data center construction grew at a 15.2% rate, business investment in information processing equipment grew at an 8.3% pace, investment in software grew at an 11.4% rate, and R&D was up at a 7.5% pace.  Without this build-out, real GDP would have grown at less than a 1% pace.  By contrast, the best news in today’s report was that Core Real GDP – which includes consumer spending, business fixed investment, and home building, and excludes more volatile categories like government purchases, inventories, and international trade – grew at a 3.9% rate in the second quarter, the fastest pace in more than three years, and is now up 2.6% from a year ago.  In the meantime, inflation was a problem, largely due to higher oil prices, with GDP prices up at a 6.2% rate in Q2 and up 4.3% from a year ago.  As a result, nominal GDP rose at a 7.9% pace in Q2 and is up 5.6% annualized in the past two years.  We expect this to drop in the quarters ahead, but if it does not the Federal Reserve will likely get more pressure for a rate hike.  One reason we think nominal GDP will drop is that the M2 measure of the money supply has grown just 4.8% annualized over the past two years, which is less than nominal GDP and less than the 6.0% pre-COVID pace when inflation averaged below 2.0%.  In other news this morning, new claims for unemployment insurance rose 9,000 last week to a still very low 197,000.  Continuing claims declined 7,000 to 1.782 million.  These figures suggest moderate payroll growth in July.

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Kevin Warsh’s second meeting as Fed Chair saw no change in rates and minimal edits to the Fed Statement, but included a press conference giving insight into what the Fed is focused on.  In an economy where Warsh described output as solid, capex and productivity as strong, and the employment market as steady, he views the answer to recent inflation problems as anything but straight forward, while making clear that the Fed is on the case.

In terms of the Fed Statement there was one key change, which is that three bank presidents previously approved by Jerome Powell dissented in favor of raising rates today, making it clear there is sentiment at the Fed to raise rates if the inflation picture doesn’t improve. At the press  conference, Warsh made clear that the Fed is committed to achieving the 2% inflation target.

Futures markets entered today’s meeting pricing in a near 100% chance of a rate hike coming by September.  Those odds are now closer to 50/50 for September with a hike now expected by October or December. Warsh reminded the markets that the Fed has tools beyond rates to work on inflation (for example, shrinking the Fed’s balance sheet), and appears to be winning the fight against the policy hawks.  The 10-year Treasury yield jumped to 4.69% today and appears to agree with this assessment. We believe he would prefer to hold off on rate hikes for the foreseeable future, but is battling the Powell faction – led by the former Fed Chair who remains on the board and as a member of the FOMC – and is working to gain the broader support of voting members to play the long game.    

It’s true that inflation measures remain above the Fed’s 2% target, and higher energy costs have shown in readings over recent months, but the M2 measure of money has been growing below the historical trend pace over recent years, and higher energy prices are likely to be offset by consumers eventually pulling back in other areas, which will see those other prices eventually decline.  We aren’t advocating for rate cuts any time soon, but we are fully on board with the Fed asking itself hard questions while they wait for more clarity on their dual mandate.  We look forward to what answers those hard questions bring. 

Brian S. Wesbury, Chief Economist

Robert Stein, Deputy Chief Economist

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Implications:  New orders for durable goods rose a modest 0.3% in June versus the consensus expected 1.8%. The shortfall comes in the midst of a resurgence in capital investment for data centers, which has been a tailwind for economic growth in the first half of the year. Beneath the modest headline, activity continues at a solid pace. Transportation is a notoriously volatile category month to month, so we prefer to focus on orders excluding transportation for a better check on the broader economy. Orders excluding transportation continue to rise, up 0.6% in June and 11.0% in the past year, the largest annual gain in more than four years. The increase in these orders was led by computers & electronic products (+3.1%), primary metals (+1.1%), and electrical equipment (+0.9%). Notably, orders for computers & electronic products are up at a 23.8% annualized pace through the first half of 2026, second only to primary metals, which are up 28.0% over that same period. Orders for fabricated metal products and industrial machinery declined last month.  However, in the past year these categories are up 10.6% and 14.4%, respectively. Arguably the most important number in today’s release is core shipments – a key input for business investment in the calculation of GDP – which rose 1.9% in June and were up at an 11.1% annualized rate in Q2 versus the Q1 average. Business investment has shown strength recently as core shipments have consistently risen for the past year, driven by a more favorable tax environment and the data center buildout. The massive capital spending from the hyperscalers – projected to reach almost $700 billion this year – has been a tailwind for GDP for the past two quarters, and should continue to prop up growth if these companies can sustain the spending pace.

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The more things change, the more they stay the same.

The US economy grew 2.0% in 2025 and it looks like it is growing another 2.0% this year.  Real GDP grew at a 2.1% annual rate in the first quarter and, as we set out below, it looks like it grew at a 2.0% rate in the second quarter.  

Which doesn’t mean everything is steady as she goes.  Data centers are where the action is and continue to grow rapidly, with the nominal value of construction of these structures up 23.0% from a year ago.  Likewise, shipments of computers and related products plus communications equipment are also up 23.0% from a year ago.

As we wrote in a recent Three on Thursday, capital spending by hyperscalers – like Amazon, Google, Meta, Microsoft, and Oracle – are projected to be almost $700 billion in 2026, which is $300 billion higher in 2026 than in 2025.  That alone would account for a full one percentage point of GDP growth.  In turn, that figure is in-line with findings from a recent paper from the St. Louis Fed on AI’s contribution to GDP growth.

Yes, it is possible that without all the investment in AI that other companies in other sectors would have easier access to capital and invest more, and that one percentage point figure doesn’t account for “crowding out” that other investment.  But it’s also the case that AI investment has led to more activity on sectors outside the technology sector, like power generation and water supply, and we are not counting that “crowding in,” either. 

The bottom-line is that in spite of the tailwind of AI and technological innovation, the overall economy is not booming.

Consumption: Auto sales soared at a 22.3% annual rate in Q2 while “real” (inflation-adjusted) retail sales excluding autos rose at a 6.8% rate.  However, real service spending – which makes up the lion’s share of consumer spending – appears up at only a 1.4% pace.  Combined, this brings our estimate of real consumer spending to a 2.2% rate, adding 1.5 points to the real GDP growth rate (2.2 times the consumption share of GDP, which is 68%, equals 1.5).

Business Investment: We estimate a 5.7% growth rate for business investment, with gains in equipment and intellectual property leading the way and commercial construction a continuing drag on growth (even including data centers, which are booming!).  A 5.7% growth rate would add 0.8 points to real GDP growth.  (5.7 times the 14% business investment share of GDP equals 0.8).

Home Building: Residential construction looks to have been unchanged in the second quarter, which is a victory of sorts considering it has contracted in every quarter since 2024.  We think this reflects a lack of workers to build homes while strict immigration enforcement makes more units available for rent.  Unchanged home construction means zero effect on the economy’s growth rate.  (0.0 times the 4% residential construction share of GDP equals 0.0).

Government: We are estimating that government purchases were still recovering in Q2 after the temporary shutdown of the federal government in the fourth quarter.  Modest growth at a 1.2% rate should add 0.2 points to the GDP growth rate (1.2 times the 17% government purchase share of GDP equals 0.2).

Trade: It looks like the trade deficit grew in the second quarter due to a surge in goods imports, although this forecast may change when a preliminary trade report arrives Tuesday morning.  For now, we’re projecting net exports will reduce the Q1 real GDP growth rate by 0.8 percentage points.

Inventories: We expect businesses added to inventories in the second quarter versus a decline in Q1, which should add what we estimate to be 0.3 percentage points to real GDP growth.

Add it all up, and we get a 2.0% annual real GDP growth rate for the first quarter, which would be lower if not for the boom in data centers.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications: New homes sales may have surprised to the upside in June, but there wasn’t much to get excited about in today’s report. Sales rose a modest 1.6% in June and now sit at a 628,000 annual rate. That sales pace remains on the weaker end of pre-pandemic levels, which has been a ceiling of sorts for activity the past couple of years.  Unfortunately, the ongoing conflict with Iran and its impact on energy prices and inflation have introduced new challenges. First, financing costs have risen, with the average 30-yr fixed mortgage rate up roughly 50 basis points since the start of the conflict.  Second, despite a new Chairman at the Federal Reserve, further rate cuts are on hold for the time being. But while buyers are unlikely to get much help from interest rates, the good news is that prices have been trending lower for new builds in the past several years. Median sales prices are down 13.5% from the peak in October 2022.  Meanwhile, the Census Bureau reports that from Q3 2022 to Q1 2026 (the most recent data available) the median square footage for new single-family homes built rose 3.7%. So, buyers are seeing a drop in the price per square foot, not just smaller/lower cost options.  This is partially the result of developers offering incentives to buyers in order to move inventory. Supply has also put more downward pressure on median prices for new homes than existing homes.  The supply of completed single-family homes has been trending down recently but is still up 280% versus the bottom in 2022. This contrasts with the market for existing homes, which continues to struggle with convincing current homeowners to give up the low fixed-rate mortgages they locked-in during the pandemic to list their homes. While financing costs remain a headwind, less expensive options and an abundance of inventories may give home sales a modest boost in 2026. In other recent news, initial jobless claims fell unexpectedly last week by 22,000 to 187,000; continuing claims declined 2,000 to 1.796 million.  These figures signal continued job growth in July.  Finally, on the manufacturing front, the Kansas City Fed Manufacturing Index, a measure of factory sentiment in that region, declined to +9 in July from +11 in June.

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An expected massive second quarter of earnings is underway for the S&P 500 Index and this week’s “Three on Thursday” takes a closer look at analysts’ expectations for earnings per share (EPS) for the S&P 500 Index. So where do Q2 earnings sit today, and where might they be headed next? For more insight, click the link below.

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