Implications: Activity in the manufacturing sector surprised to the upside for the third month in a row in March, while the prices index signaled that inflation pressures remain stubbornly high.  The good news is the 52.7 level registered in March marks the first time the ISM Manufacturing Index has been in expansion territory for three consecutive months since 2022. While we remain cautious given last year’s head-fake (where the index briefly rose above 50 in January and February), the recent strength is a welcome development for an industry that has faced an army of headwinds in recent years.  Looking at the details, growth broadened slightly in March, with thirteen out of the eighteen major manufacturing categories reporting growth (versus twelve in February), while three reported contraction, and two reported no change.  The major measures of activity were mixed: the index for new orders declined to 53.5 from 55.8, while the production index increased to 55.1 from 53.5, but both remain in solid expansion territory, signaling growth.  It’s important to remember that order books have been very weak since 2023, and manufacturers had to rely on their order backlogs to keep production going.  The great news is that backlogs started growing again 2026, with the index sitting at 54.4 in March – now the third consecutive month in expansion territory – when before it had contracted for 39 straight months going back to September 2022.  Despite signs of improving demand, it has not been enough to meaningfully change hiring efforts in the manufacturing industry.  The employment index ticked down to 48.7 in March, signaling contraction, now for the 30th consecutive month.  The even worse news was a sustained pickup in pricing pressures, with the prices index jumping to 78.3 in March from 70.5 in February – markedly higher than the 59.0 level registered two months ago in January. With the ongoing war in Iran and the recent Supreme Court ruling against much of the Trump’s Administration tariffs, we expect volatility to continue for this category in the months ahead.   In other news this morning, construction spending declined 0.3% in January, as drops in homebuilding and manufacturing construction fully offset a large increase for highway & street projects.  In other manufacturing news, the Kansas City Fed Manufacturing Index – a measure of factory sentiment in that region – rose to 11 in March from a reading of 5 in February, the highest level since mid-2022.  Meanwhile, the Chicago Purchasing Managers Index (PMI) – where readings above 50 signal growth – declined to 52.8 in March from 57.7 in February, signaling slower growth than the previous month.

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Implications:  Retail sales generated a strong headline for February, but the broader picture remains soft.  Looking at the headline, overall retail sales beat expectations and rose 0.6% for the month – the largest increase since July – while previous activity was revised higher.  However, much of that increase can be attributed to a bounce-back in sales after severe winter weather held back activity in January.  Taking a step back, overall retails sales have risen 3.7% in the past twelve months, but are up just 1.8% annualized in the last six months.  It’s also important to remember the impact of inflation.  “Real” inflation-adjusted sales are up 1.3% in the past twelve months, but are down at a 0.7% annualized rate over the last six months.  Looking at the details for February itself, the largest increases came from a 1.2% recovery in auto sales, while rising purchases at gasoline stations (+0.9%) also contributed.  We like to follow “core” sales, which strip out the volatile categories for autos, building materials, and gas stations – important for estimating GDP.  This measure rose 0.4% in February but was revised slightly lower in previous months.  Within the core grouping, rising sales at nonstore retailers (+0.7%) contributed, along with a rebound across most brick-and-mortar categories.  Meanwhile, the category for restaurants & bars – the only glimpse we get at services in this report – rose 0.4% in February after declining in three out of the four months prior.  These sales are up 5.2% in the last year (above the increase for overall sales) but will be worth watching in the months ahead as a bellwether for the consumer's overall well-being.  In other recent news, the M2 measure of the money supply rose 0.9% in February (+11.1% annualized), the fastest monthly pace since October 2021.  Despite the jump, it’s up at a 5.3% rate in the past six months and 4.9% in the past 12 months, which still lag the 6.0% growth rate in the ten years prior to COVID.  On the employment front, ADP’s measure of private payrolls increased 62,000 in March versus a consensus expected 40,000.  We’re estimating Friday’s official report will show a nonfarm payroll gain of 76,000 with the unemployment rate remaining steady at 4.4%.  Keep in mind this report falls on Good Friday, and along with many other companies in the US, First Trust will be closed in observance of this sacred day. We will release our analysis on Monday after Easter.  In other employment news, initial jobless claims rose 5,000 two weeks ago to 210,000, while continuing claims fell 32,000 to 1.819 million.  Finally on the housing front, the FHFA index rose 0.1% in January and is up 1.6% in the past year, while the national Case-Shiller index rose 0.2% in January and is up 0.9% from a year ago.

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The US economy grew a pedestrian 2.0% last year and the Atlanta Fed’s GDP Now is currently projecting real GDP growth at a 2.0% annual rate in the first quarter.  If anything, we think there is more downside risk than up to the first quarter projection.

Yes, we are well aware of the ongoing revolution in AI and the benefits this could have for productivity growth.  But the federal government remains substantially larger than it was pre-COVID and even more so than it was prior to the Global Financial Crisis. This remains an albatross around the economy’s neck…holding back investment and reducing potential growth.

Meanwhile, there are numerous reasons to be concerned with the economy.  What many call the “K-Shaped Economy,” which is just a cute way of talking about inequality, may no longer be providing support for economic growth.  The Federal Reserve’s extremely loose monetary policy of 2020-21 artificially held down interest rates and lifted asset prices, which helped those who owned assets.  Meanwhile, those who held few assets had their budgets hit hard by the inflation caused by easy money.

Moody’s Analytics estimates that the top 20% of earners are driving a “luxury economy” and are responsible for 63% of total US spending.  Stock and home prices are up sharply in recent years, which has likely driven “wealth effect” spending.

But at the Friday close, the S&P 500 is back to where it was eight months ago.  If this continues, it could have a negative impact on the consumer spending growth that’s been happening on the upper end of the income spectrum.

This is worrisome because we already see stress at the lower end.  The New York Fed says that 5.21% of auto loan balances are 90+ days delinquent, the second highest level going back to at least 1999, even higher than for most of the so-called Global Financial Crisis in 2008-09.  The share of credit card balances that are 90+ days delinquent is 12.70%, the highest since 2011.  Meanwhile, student loan delinquencies have soared now that COVID-era repayment amnesties are over.  If both limbs of the “K” sag, the economy could be in trouble.

Add to this, the fact that Iran seems unwilling to capitulate.  If the Fed isn’t on hold, and cuts rates, this risks inflation. Both are bad for the market.  We hope that the war ends soon, but President Trump may now be caught between his natural inclination to avoid a prolonged conflict and a desire to show that fear of the TACO trade (“Trump Always Chickens Out”) can’t bully him.  This is especially true if the Trump team thinks Iran is counting on rising oil prices and falling stocks to force the US to back off.

The US is now a net petroleum exporter and gets only a small share of its oil from the Middle East.  But there are many other countries, especially western advanced economies, that are highly dependent on Middle East oil and other raw materials.  These countries are already under stress with the Strait of Hormuz essentially closed.  If war continues, this pain will intensify and growth will slow.  If western trading partners suffer, that’s an additional headwind for US growth.

And don’t forget troubles in private credit markets.  We don’t see a systemic crisis, but clearly this is a problem, and could further diminish investment flows.

The recent drop in US stocks is nothing like the “Liberation Day” mini-panic in early 2025.  This time around, it’s less panic and more of a measured reassessment of the headwinds facing the US economy.  The market needs a lot of things to go right to find its footing again.  Including a smaller government.  The odds of that happening in the near-term seem less than stellar. 

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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In 2025, the United States generated a record 4.43 thousand terawatt-hours (TWh) of electricity, a 2.8% increase from 2024. In this week’s “Three on Thursday,” we translate electricity concepts into real-world terms and show just how much new electricity the U.S. will need to power the next phase of economic growth. To learn more, click on the link below.

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We wrote the above MMO title “Topsy Turvy World” two days ago.  On cue: the stock market has a massive reversal to the upside.  At one point last night, Dow futures were trading below 45,500, this morning they traded over 47,100 – a 1,600 point swing.

Why?  President Trump backed off from threatening to bomb energy assets in Iran and mentioned “cease fire” talks in a post online.  Up and down oil prices, volatile stock prices, and bond yields, violent moves in gold prices…that’s all part of the fog of war.

But that’s not the only issue investors and policy makers have to deal with.  At his press conference last week Fed Chairman Jerome Powell made a surprisingly transparent comment, admitting that many members of the Fed have “no conviction” on how the economy will evolve.

After telling us all that inflation would be “transitory” a couple of years ago, we think Jerome Powell should use this phrase more often.  The Federal Reserve was way too loose during COVID and was so because it chose politics over the target of 2.0% inflation.

Powell now claims he’s all for “Fed independence,” but the Fed accommodated huge deficits and COVID lockdowns and only has itself to blame for making politicians angry.  Especially now that there are rumors that some Fed members want to “raise” rates into a war and higher oil prices.  That makes zero sense and many see it as continuation of Powell’s fights with the President.

But Powell is right, there is a high degree of uncertainty about the economy right now.  Let’s start with the Iran War.

The Trump Administration seems less likely to press on for a widespread popular uprising and more likely looking for some sort of military coup by leaders who will throw off the mullahs and commit to the country becoming more friendly with the West.  Think President El-Sisi in Egypt, but with oil money.  However, with much of the leadership killed or leaving, who the Administration negotiates with is a mystery.

Meanwhile, the hard numbers on the economy are tepid.  Real GDP growth for the fourth quarter of last year, which the Atlanta Fed GDP Now model pegged as high as 5.4% back in January, has been revised down to just 0.7%.  For the labor market, private payrolls are up 33,000 per month in the past year, but without health care & social assistance private payrolls are down.  Manufacturing and retail jobs are both down.

When it comes to inflation, recent figures have been downright bizarre.  Producer prices rose 0.7% in February and are up 3.4% from a year ago.  But the increase has been led by the services sector, not the goods sector.  This is the opposite of what the Fed and many analysts feared a year ago.  Prices for goods in the PPI are up 2.5% in the past year, while services prices are up 3.8%.  We see a similar pattern for consumer prices where services prices are up 3.1% in the past year while commodity prices are up 1.3%.  The effect of tariffs has been much more muted than many feared.  

Yes, inflation is still above the Fed’s 2.0% target.  However, monetary policy has been relatively tight the past few years after the massive surge in the money supply in 2020-21.  In the ten years prior to COVID, the M2 measure of money grew about 6.0% per year with inflation averaging at or below 2.0%.  In the past year, M2 is up just 4.3%.  The Fed is not too loose right now, which is why chatter about the next rate move being a hike doesn’t make sense.  

In the meantime, the stock market has been hit, but not excessively so.  Some investors are worried it’s no longer increasing, but at the market close on Friday, the S&P 500 was down a modest 6.8% from the pre-Iran peak back in late January.  If these investors are freaking out right now, wait until they get a full correction or even a bear market.  In our view, the S&P 500 has been overvalued for quite some time, so although fingers are pointing right now to the conflict in the Middle East, we believe there was substantial downside risk to equities even in the absence of the war.

Yes, the technological progress being made with Artificial Intelligence is impressive.  But we think there has also been some AI hype that is overdone in the short-run even though it will be transformative in the long-run.

The Fed’s decision made sense: don’t change the target for short-term interest rates if we don’t know what the world will look like tomorrow.  But investors need to remember a couple of important things.  Rate cuts, if they ever come, are less important than the money supply.  A cease fire in Iran will be positive in the short-run, but we still live in a volatile political world with the Trump Administration fighting the enemies of freedom on multiple fronts.  And, finally, stocks are expensive. Don’t ever get complacent, it’s a Topsy Turvy World.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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In this week’s “Three on Thursday,” we examine the state of student loan debt through 2025, and the financial stress it continues to impose on millions of Americans. To see where things stood at the end of last year, click on the link below.

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Implications: Don’t get too concerned about today’s headline decline, this isn’t the start of another housing bust. While January posted the largest monthly decline in sales since 2013, the main culprit was likely severe winter storms across the US that held back buyer activity. Look for a rebound in activity next month as this temporary factor reverses. The overall trend in sales likely remains around pre-pandemic levels which has been a ceiling of sorts for activity the past couple of years.  Unfortunately, the Iran War and its expected impact on energy prices and inflation have introduced new challenges. First, financing costs have recently spiked in response, with the average 30-yr fixed mortgage rate up 20 basis points in the past couple weeks to 6.3%. Second, the Federal Reserve decided to take a pause on rate cuts in yesterday’s meeting as they wait to see the impacts of the conflict on US economic data. 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% from the peak in October 2022.  The Census Bureau reports that from Q3 2022 to Q4 2025 (the most recent data available) the median square footage for new single-family homes built fell 9.7%. So, while most of the drop in median prices is due to smaller/lower-cost homes, there has also been a drop in the price per square foot.  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 is up 300% versus the bottom in 2022 and is currently at the highest level since 2009. 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 an open question, less expensive options and an abundance of inventories may give home sales a modest boost in 2026. In other news this morning, initial jobless claims declined 8,000 last week to 205,000, while continuing claims rose 10,000 to 1.857 million. Finally, on the manufacturing front, the Philadelphia Fed index – a measure of factory sentiment in that region – rose to +18.1 in March from +16.3 in February.

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In what is supposed to be Jerome Powell’s next to last meeting as chairman, there was plenty for the FOMC to discuss, but little action taken.  As expected, there was no rate cut at today’s meeting, but changes to economic projections and comments at the press conference gave some light into how the Fed is processing political and geopolitical events, and how those events are shaping the Fed’s outlook.

The only notable change in the Statement from January was the addition of a new sentence stating the “implications of developments in the Middle East for the U.S. economy are uncertain.”  Notably Fed Governor Miran once again voted against today’s decision to keep rates unchanged, preferring a 0.25% rate cut. Governor Waller, who also dissented in favor of a cut back in January, voted with the remaining FOMC members to keep rates unchanged.  

Moving to the Summary of Economic Projections (the “dot plots”) shows inflation concerns rising, but anticipated to be short-lived.  The Fed’s preferred PCE inflation measure is now forecast to rise 2.7% in 2026, versus a 2.4% forecast back in December. But inflation is still expected to move toward the longer-run 2.0% inflation target by the end of 2027.  At the same time, the Fed slightly upgraded the outlook for GDP for 2026 (to 2.4% from 2.3%) as well as for each of the next two years.  The unemployment rate forecast for 2026 remained unchanged.  

The question now becomes, should the Fed react to what they expect is a temporary inflation impact and largely outside of their control?  Early in the press conference, Powell made a surprisingly transparent and honest comment that even the FOMC is taking today’s forecasts with a grain of salt, stating that many members have “no conviction” on how things will evolve and therefore moved little from what they had forecast before events in Iran began. 

Instead, the Fed is focused on goods inflation and watching if tariff-related price increases from last year roll off in 2026. It’s a bit odd the emphasis the Fed continues to put on goods inflation, considering PCE goods prices rose 1.3% in the twelve months ending in January, compared to 3.5% inflation in the less tariff-exposed services sector.  Yet when this stubbornly high services inflation, most notably in the “super-core” inflation category (PCE services excluding energy and housing) that the Fed itself created during COVID came up during Q&A, Powell largely dismissed it, saying simply that it’s frustrating these prices haven’t declined, but they should come down eventually.  Apparently if it doesn’t fit the Fed narrative of the day, it’s not worth dwelling on.

Finally, Powell addressed his future with the Fed.  In the event that a new Chair is not confirmed before Powell’s term ends on May 15th, he will stick around and continue to serve his role until a replacement is appointed. He also stated that he has no intention of leaving the Federal Reserve Board of Governors until his ongoing investigation with the Department of Justice is well and truly behind him.  As a reminder, his term as Fed Chair ends mid-May, but his seat on the Board of Governors runs through January of 2028. It’s unusual for a Fed Chair not to vacate their seat on the board when their Chairmanship is up, but it is not required, and Powell may linger at the Fed for the foreseeable future.     

What should you takeaway from today’s meeting?  The Fed isn’t sure how the economy, inflation, or the employment market will react to events in Iran, and they aren’t interested in guessing.  There are six weeks between now and the next FOMC meeting at the end of April, and by then we should have a much better idea of both the magnitude and duration of the economic ripples out of the Middle East. In terms of inflation, we still believe that the M2 money supply is a much more reliable tool for forecasting sustained inflation. To track our ongoing analysis of how oil flows, tariffs, employment, and the money supply are impacting the outlook for the United States, we would encourage you to keep an eye on our Three on Thursday publications.

Brian S. Wesbury – Chief Economist

Robert Stein – Deputy Chief Economist

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Implications: Producer prices rose sharply higher in February, increasing 0.7%, and up 3.4% from a year ago. In contrast to prior months, the increase was broad-based, with both the headline and core readings beating consensus expectations. As a result, what little odds of a March rate cut that might have existed before this report should go to zero.  However, a look at the details shows a slightly less cautionary story. More than half the gain in February was due to a 0.5% increase in service costs. Service costs have risen significantly in the past three months, up at an 8.1% annualized rate in that timeframe. However, with volatile readings from trade and transportation due to the Supreme Court ruling on the Trump Administration’s tariff policies, stripping out these categories offers a deeper look at the underlying trends. A version of “core” services, which excludes the categories of trade, transportation, and warehousing increased 0.6% in February, but is up at a more moderate 3.4% annualized rate in the past three months. Many assumed it would be goods prices that would lead inflation higher, given the higher tariff rates under President Trump, and while goods prices increased 1.1% in February, twenty percent of the rise is due to a 48.9% jump in vegetables. On top of that, the strong February reading follows two months of price declines, meaning goods prices are up a much slower 2.5% in the past year. It must be noted that while the goods reading was propelled by the rise in prices for energy (+2.3%) and food (+2.4%), “core” producer prices – which excludes those typically volatile categories – also rose 0.5% in February. Expect volatility in the months ahead as the ongoing war in Iran puts pressure on oil prices and disrupts global supply chains. However, sustained movements in overall inflation are led by the money supply, which is up 4.3% in the past year versus the 6% trend prior to COVID when inflation remained low. Volatility may continue month-to-month, but we expect this monetary tightness will bring inflation down, eventually leaving room for rate cuts to restart at some point later in 2026. In other recent news, pending home sales, which are contracts on existing homes, rose 1.8% in February, following a 1.0% decline in January, suggesting a modest rise in existing home sales (counted at closing) in March.

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Implications: Industrial production posted a modest gain in February, rising for the fourth consecutive month to hit a new post-COVID high. More broadly, industrial production is up 2.5% since the Trump Administration took office in January 2025, despite huge shifts in trade policy and tariff uncertainty.  Meanwhile, the manufacturing sector is up 2.6% over that same period. While these numbers aren’t enough to get excited about yet, it’s clear that a new upward trend in activity is emerging. Digging into the details for February, manufacturing was the biggest source of strength, rising 0.2%. The volatile auto sector contributed to the gain, with activity jumping 1.6% in February.  Manufacturing ex-autos (which we think of as a “core” version of industrial production) also posted a gain of 0.1%. The typical bright spots in the “core” measure were present in today’s report as well.  Production in high-tech equipment, which has been a reliable tailwind recently due to investment in AI as well as the reshoring of semiconductor production, increased 0.7% in February.  High-tech manufacturing is up a strong 8.6% in the past year, the fastest 12-month growth rate of any category. However, the manufacturing of business equipment wasn’t far behind, up 6.3% in the past year, signaling reindustrialization in the US outside of just the high-tech industries mentioned above. The mining sector was also a tailwind in February, rising 0.8%. Gain in oil and gas production and the drilling of new wells more than offset a decline in the extraction of other metals and minerals.  Finally, utilities output (which is volatile and largely dependent on weather) declined 0.6% in February. In other manufacturing news this morning, the Empire State Index – a measure of factory sentiment in the New York region – declined to -0.2 in March from +7.1 in February. Finally, the NAHB index, a measure of homebuilding sentiment, increased to 38 in March.  Keep in mind readings below 50 signal a greater number of builders view conditions as poor versus good, now the 23rd consecutive month that has been the case.

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