Implications:  The Fed has now received the last key piece of data to be released before their meetings next week, and it looks very likely it will signal that rate cuts will start in September.  PCE prices – the Fed’s preferred inflation measure – rose 0.1% in June and is up 2.5% in the past year compared to a 3.2% gain in the year ending in June 2023.  “Core” prices, which exclude the ever-volatile food and energy categories, rose 0.2% in June and are up 2.6% versus a year ago, a big improvement from the 4.3% reading for the twelve months ending June 2023.  It’s too early to call victory with inflation still above the Fed’s 2.0% target, but the numbers have moved in a positive direction since the last time that the Fed met.  Transitioning to a focus on how consumers fared in June shows some moderate growth.  Personal income rose 0.2% in June and is up 4.5% in the past year.  Private-sector wages and salaries led the way, up 0.2% on the month and up 4.1% in the past year.  Unfortunately government activity continues to run hot as well, with government transfer payments rising 0.3% in June while government pay rose 0.6% and is up 8.5% in the past year, marking the largest twelve-month increase in more than three decades. We don’t think the growth in government pay – or massive government deficit spending – is sustainable or good for the US economy.  Consumer spending rose 0.3% in June, led by outlays on services which rose 0.4% on the month and are up 6.8% in the past year.  Goods spending rose 0.1% in June and is up 2.0% from a year ago.  When adjusting for inflation, consumption rose 0.2%.  We are closely watching the service sector as the driver of consumer activity both now and in the near future, and we expect activity to temper as elevated interest rates and continued inflation pressure continue to take their toll.  We are also keeping an eye on the savings rate (the percent of disposable income that consumers save), which hovered around 6.0% pre-COVID, skyrocketed with the excess money printing during COVID, and has now been hovering around 3.5% over recent months.  This shortage in savings will catch up with consumers down the road. In other recent news on the manufacturing front, the Kansas City Fed Manufacturing Index, a measure of factory activity in that region, fell to -13 in July from -8 in June, following a similar negative reading earlier this week from the Richmond Fed.  These readings suggest the national ISM report to arrive next Thursday will remain below 50, signaling contraction.

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In this week’s edition of “Three on Thursday,” we take a deeper look at the employment landscape in the United States. Every month, usually on the first Friday, the Bureau of Labor Statistics reports jobs data. These data come from two surveys of establishments and households. Much can be gleaned from both reports, and over time the employment components tend to track each other closely. But over the first half of the year, some cracks are starting to form in employment, weakness that we believe will lead to a further slowdown in hiring in the second half of the year. 

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Implications:  Orders for durable goods plunged 6.6% in June, the largest monthly decline since the shutdown months of March and April 2020, as transportation orders plummeted.  However, the details in today’s report look better than the headline number suggests.  Transportation orders, particularly for aircraft, are very volatile month-to-month, and the outsized decline in June is very likely to swing and push orders positive in the months ahead.  Strip out the volatile transportation sector, and durable goods orders rose 0.5% in June, beating expectations with most major categories showing gains. Machinery orders led non-transportation orders higher, up 1.6% in June, while electrical equipment (1.3%), computers and electronic products (+0.8%), and fabricated metal products (+0.2%) also rose. Primary metals (-0.1%) were the lone other category to show a decline.  The most important number in the release, core shipments – a key input for business investment in the calculation of GDP – rose a modest 0.1% in June but declined at a 2.3% annualized rate in Q2 versus the Q1 average, the largest single-quarter decline since Q2 2020.  Shipments have moderated significantly since surging in late 2020 when PPP loans and stimulus payments flooded the system, and have now declined in two of the last three quarters.  While GDP readings continue to run positive (see here for today’s report on Q2 GDP), we expect the trend of turbulent readings to continue as the economy feels the lagged effects of the Federal Reserve’s tightening of monetary policy.  In other news this morning, initial claims for jobless benefits fell 10,000 last week to 235,000, while continuing claims fell by 9,000 to 1.851 million.  The figures are consistent with continued job gains in July, but at a slowing pace.

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Implications:  There are dark clouds on the horizon for the US economy, but the storm isn’t here yet.  Real GDP grew at a 2.8% annual rate in the second quarter, beating the consensus expected 2.0%.  Most of the growth was accounted for by an increase in consumer spending, which grew at a 2.3% rate.  The largest surprise was a hefty increase in business investment in equipment, which grew at an 11.6% pace (likely AI and chip related), the fastest pace in more than two years. We like to follow “core” GDP, which includes consumer spending, business fixed investment, and home building, while excluding government purchases, inventories, and international trade, the latter of which are very volatile from quarter to quarter.  Core GDP increased at a healthy 2.6% rate in Q2 and is up 2.9% from a year ago.  However, not all the news was good.  Net exports were a 0.7 percentage point drag on the growth rate as imports surged, partially due to some importers trying to get ahead of a possible dockworker strike later this year.  In turn, and likely related to the import surge, inventory accumulation added 0.8 percentage points to the real GDP growth rate and that’s unlikely to continue.  Meanwhile, inflation has not yet been fully tamed.  GDP prices rose at a 2.3% pace in Q2 but were up 2.6% from a year ago.  That’s progress from the 3.5% annual increase we were seeing a year ago, but still above the Federal Reserve’s 2.0% target.  Nominal GDP – real GDP growth plus inflation – increased at a 5.2% rate in Q2 but is still up 5.8% from a year ago.  Because of today’s numbers – moderate economic growth, decelerating inflation – many analysts and investors may think the economy is in the clear, without any trouble ahead.  By contrast, we believe the lags between monetary policy and the economy are long and variable and that the tighter monetary policy of the last couple of years has yet to have its full affect.

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Implications:  New home sales came in weaker than expected in June, posting another decline following the largest monthly drop since 2022.  It looks like activity is stuck in low gear, with sales having normalized roughly at the same pace they were in 2019 before COVID. With 30-year fixed mortgage rates still above 7%, some potential buyers may be delaying purchases in the hopes of widely expected rate cuts from the Federal Reserve improving affordability in the future. Assuming a 20% down payment, the rise in mortgage rates since the Federal Reserve began its current tightening cycle amounts to a 23% increase in monthly payments on a new 30-year mortgage for the median new home.  The good news for potential buyers is that the median sales price of new homes has fallen 9.3% from the peak in 2022. It does look like a small part of this decline reflects a lower price per square foot as developers cut prices.  The Census Bureau reports that from 2022 to 2023 (the most recent data available) the median price per square foot for single family homes sold fell 1.1%. While that decline is modest, it represents a stark reversal from the 45% gain from 2019 to 2022.  That said, most of the drop in median prices is likely due to the mix of homes on the market including more lower priced options as developers complete smaller properties. Supply has also put more downward pressure on median prices for new homes than existing homes.  The supply of completed single-family homes is up over 200% versus the bottom in 2022. Total inventories have continued to climb higher as well, hitting a new post-pandemic high in June. 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.  Though not a recipe for a significant rebound, more inventories giving potential buyers a wider array of options will keep a floor under new home sales.  One problem with assessing housing activity is that the Federal Reserve held interest rates artificially low for more than a decade, and buyers started to believe those low rates were normal.  With rates now reflecting true economic fundamentals, the sticker shock on mortgage rates for potential buyers is very real.  However, we have had strong housing markets with rates at current levels in the past, and as long as the job market remains strong and buyers understand that the past was a mirage, it’s possible they will eventually adjust.  Finally, the Federal Reserve released monthly figures on the money supply yesterday showing M2 rose 0.3% in June and is up 1.0% in the past year.  After surging in the first two years of COVID, M2 declined from early 2022 through early 2023 and has since been close to flat.  As we mentioned in our recent MMO it looks like this is finally putting downward pressure on both inflation and the growth rate of nominal GDP.

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Implications:  The typically strong spring selling season failed to materialize in 2024, with activity falling 5.4% in June, the fourth decline in a row. It looks like the housing market remains stuck in low gear due to affordability. First, sales are still facing headwinds from mortgage rates that remain above 7% and some buyers are likely delaying purchases until after the Fed delivers on widely anticipated rate cuts. Second, home prices are rising again (hitting a new high in June) with the median price of an existing home up 4.1% from a year ago.  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 45% 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 continued volatility in financing costs will cause some indigestion. Notably, sales of homes priced at $1 million and above have risen 3.6% in the past year versus a decline of 5.4% for all existing home sales. This demonstrates that, at least at the higher end of the market, both buyers and sellers are beginning to adjust to the new reality of higher rates. However, outside the most expensive segment many existing homeowners remain reluctant to sell due to a “mortgage lock-in” phenomenon, after buying or refinancing at much lower rates before 2022.  This remains a major impediment to activity by limiting future existing sales (and inventories).  However, there are signs of progress with inventories rising 23.4% in the past year.  That has helped push the months’ supply of homes (how long it would take to sell existing inventory at the current very slow sales pace) up to 4.1 in June, the highest since May of 2020 although still below the benchmark of 5.0 that the National Association of Realtors uses to denote a normal market.   A tight inventory of existing homes means that while the pace of sales looks like 2008, we aren’t seeing that translate to a big decline in prices.  In other news on the manufacturing sector, the Richmond Fed index, a measure of factory activity in the mid-Atlantic, fell to -17 in July from -10 in June.

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There are signs US economic growth is slowing down.  In particular, jobless claims, perhaps the best high-frequency economic indicator, have averaged 235,000 per week in the last four weeks versus 211,000 in the first quarter.  Meanwhile, continuing jobless claims are creeping up while overall retail sales are up a meager 0.2% in the past six months, slower than the pace of inflation.

The US is not in a recession at this point but higher claims and soft sales, along with a renewed deceleration in inflation (consumer prices ticked down 0.1% in June), suggest that the drop in the M2 measure of the money supply from early 2022 through late 2023 is finally gaining traction.

We may also be witnessing the end of the temporary and artificial impact of last year’s surge in the budget deficit.  In the absence of the Supreme Court’s decision to overturn much of President’s Biden’s plan to forgive student loans, the budget deficit would have been 7.5% of GDP last year.  That’s well larger than any year on record when the US was not engaged in a World War and the unemployment rate was below 4.0%.

We estimate that Real GDP expanded at a 2.1% annual rate in the second quarter, mostly accounted for by an increase in consumer spending.  (This estimate is not yet set in stone; reports Wednesday about international trade and inventories might lead to an adjustment.)

Consumption: “Real” (inflation-adjusted) retail sales outside the auto sector grew at only a 0.3% annual rate in Q2 but auto sales rebounded at a 9.8% rate.  Meanwhile, it looks like real services, which makes up most of consumer spending, grew at a 2.1% pace.  Putting it all together, we estimate that real consumer spending on goods and services, combined, increased at a 2.1% rate, adding 1.4 points to the real GDP growth rate (2.1 times the consumption share of GDP, which is 68%, equals 1.4).

Business Investment:  We estimate a 1.7% growth rate for business investment, with gains in intellectual property leading the way, while commercial construction declined slightly.  A 1.7% growth rate would add 0.2 points to real GDP growth.  (1.7 times the 14% business investment share of GDP equals 0.2).

Home Building:  Residential construction grew in the second quarter in spite of some lingering pain from higher mortgage rates.  Home building looks like it grew at a 4.9% rate, which would add 0.2 points to real GDP growth.  (4.9 times the 4% residential construction share of GDP equals 0.2).

Government:  Only direct government purchases of goods and services (not transfer payments) count when calculating GDP.  We estimate these purchases were up at a 1.7% rate in Q2, which would add 0.3 points to the GDP growth rate (1.7 times the 17% government purchase share of GDP equals 0.3).

Trade:  Looks like the trade deficit expanded in Q2, as exports grew but imports grew much faster.  In government accounting, a larger trade deficit means slower growth, even if exports and imports both grew.  We’re projecting net exports will subtract 0.8 points from real GDP growth.

Inventories:  Inventory accumulation looks like it picked up in Q2 relative to Q1, translating into what we estimate will be a 0.8 point addition to the growth rate of real GDP.

Add it all up, and we get a 2.1% annual real GDP growth rate for the second quarter.  Good news compared to a recession but not a great starting point if a tighter monetary policy starts to bite harder.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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In this week’s edition of “Three on Thursday,” we examine some key high-frequency data to see how things stand a few years after the COVID-19 shutdowns of 2020. Many believed that the world would be forever changed and that things would never return to their pre-pandemic state. However, the data show that the post-COVID world resembles the pre-COVID world in many ways.

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Implications:  Industrial production continued to beat expectations in June, rising for the second month in a row due to broad-based gains in every major category.  Manufacturing was the biggest positive contributor, rising 0.4%.  Looking at the details, auto production was the biggest contributor to June’s gain, jumping 1.6%. That said, non-auto manufacturing (which we think of as a “core” version of industrial production) also posted a gain of 0.2% in June. What’s interesting about today’s report is that it shows activity in manufacturing has been broadening recently. We have been highlighting the production of high-tech equipment in these reports, which is up at a 13.3% annual rate in the past three months, likely the result of investment in AI as well as the reshoring of semiconductor production. This is consistent with the broader post-COVID trend of consumer preferences shifting away from goods and towards services leaving capital goods as the driver of manufacturing activity.  However, the demand for consumer goods seems to be reviving of late, with manufacturing activity in that sector up at a healthy 10.3% annual rate in the past three months. Notably, this is the fastest three-month pace since early 2021 as lockdowns were still in full effect.  The mining sector was also a tailwind in June, with activity increasing 0.3%.  Gains in the production of oil and gas more than offset a slowdown in the drilling of new wells and the extraction of other minerals.  Finally, the utilities sector (which is volatile and largely dependent on weather) was also a source of strength in June, rising 2.8%.  Part of the recent strength in industrial production has been a surge in utilities demand, which is up at an unsustainable 39.2% annualized rate in the past three months due to warmer than normal temperatures driving demand for air conditioning which will normalize in the months ahead.

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