Implications:   Despite higher tariffs in April, inflation came in below expectations and the twelve-month reading dropped to the lowest level since the inflation surge began back in early 2021.  Looking at the headline, consumer prices rose 0.2% in April versus a consensus expected +0.3%, the third month in a row below consensus expectations, and comes on the heels of the first outright monthly decline since the COVID lockdowns.  Cooler inflation readings in recent months have in turn led to a swift drop in the year-ago comparison, from 3.0% in January to 2.3% in April.  Looking at the details, energy prices rose 0.7% in April with higher prices for natural gas and electricity offsetting a decline in gasoline prices.  Food prices declined 0.1%, as prices at grocery stores dropped the most since 2020, including the biggest drop for egg prices since 1984.  “Core” prices, which strip out food and energy, rose 0.2% in April versus a consensus expected +0.3%, with the twelve-month reading staying at 2.8%, the second month in a row below 3.0% since the inflation surge began in 2021.  The main driver of core inflation has been housing rents, which continue to outpace most categories (+0.4% in April), though not as much as in years prior.  It appears that companies are in no rush to pass along new tariffs to consumers, as apparel prices (-0.2%) and used car prices (-0.5%) both fell while prices for new cars were flat.  We also like to follow “Supercore” inflation – a subset category of prices that excludes food, energy, other goods, and housing rents.  Fed Chair Jerome Powell said back in 2022 that they follow this category closely, though never seems to mention it anymore, perhaps because of the lack of progress it’s had since their tightening cycle began.  However, it appears the tide has finally turned for the category, with supercore prices up at a 0.7% annualized pace in the last three months, while the year-ago comparison has fallen from 4.0% in January to 2.7% in April.  Notable decliners this month within the supercore category were prices for airline fare (-2.8%), and hotels (-0.2%).  Although inflation is still above the Fed’s 2.0% target, given the lags in monetary policy and slow growth in the M2 measure of the money supply, it is time for the Fed to consider reducing short-term rates slightly in the months ahead.  In other news last week, nonfarm productivity (output per hour) declined at a consensus expected 0.8% in the first quarter of 2025, as output fell while hours rose.  In the past year, productivity is up 1.4%, the smallest year-to-year change since early 2023. On the labor front, initial jobless claims fell 13,000 to 228,000, while continuing claims fell 29,000 to 1.879 million.  These figures are consistent with continued job growth in May, but at a slower pace than last year.

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Back on January 10, 2025, it cost $1.024 to buy one Euro.  Last Friday, the $/Euro exchange rate was $1.125 – a drop in the value of the dollar of about 10%.  Similar moves in the value of the US dollar versus the British pound, Japanese yen, and Canadian dollar also occurred.

Many analysts have jumped on this drop in the dollar to attack President Trump’s tariff policies…basically saying that if we keep heading down this road foreigners will pull back from investing in the US, the dollar will fall, overseas investments will outperform, and the US will undermine its global exceptionalism.

As a quick aside, while panic-stricken, politically-motivated attacks are nothing new, the fear generated by “end-of-the-world-as-we-know-it” forecasts since 2008 have reached a frenzy.  Investors would be better served by staying level-headed.

First of all, think of how many times you have read a headline that “billionaires are selling all their stocks,” or “the dollar is dead,” or “a crash, or depression, is coming.”  Especially in the past seventeen years since 2008.

And none of these have happened.  So, please stay level- headed.  Yes, the dollar has moved sharply lower in the past four months or so, but if we look at five- or ten-year timeframes it is right in the middle of its trading range.   

Yes, European stocks have outperformed US stocks this year, but European stocks are still trailing by a significant amount over the past decade or more.

So, what explains the movement in the dollar?  Here is a theory that gets too little attention.

Everyone knows that there was a huge surge in the US trade deficit as importers were front-running tariffs.  So, let’s think about what this means.  When people sell goods to the US, they get dollars.  In fact, there is a school of economic thought that says the world must run trade deficits with the US because the dollar is the world’s reserve currency and the world needs dollars to both trade and back their own sovereign currencies with one of the most trusted assets in the world.

Well, if this is true, and we believe it is, then how many dollars does the world really need?  Between 2010 and 2020, the trade deficit averaged about $40 billion per month.  From 2020 to 2024, the trade deficit averaged about $70 billion per month, but this was probably at least partly COVID induced…the US opened up faster than other countries.

Then in December, the trade deficit hit $98 billion, and then $131 billion in January, $123 billion in February, and $140 billion in March.  If we compare this to the $70B per month average from 2024, in just 4 months of 2025, the US has sent $212 billion extra dollars overseas.  $212 billion!!!!

Assuming that the demand for use of the dollar in international trade did not change one bit, that $212 billion of extra dollar supply in foreign hands would certainly knock its value down on foreign exchange markets.  In other words, no wonder the dollar fell this year.  We flooded the world with dollars by massively increasing our trade deficit.

Well, we believe the front-running comes to an end soon.  Our bet is that this will lead to a stronger dollar as supply and demand come back into balance.  The dollar is not dead or dying.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Rare earth minerals are the unsung heroes of modern technology. From smartphones and wind turbines to electric vehicles and advanced defense systems, these 17 elements play a critical role in the 21st-century economy. In this week’s Three on Thursday, we dig into the numbers behind global rare earth production, U.S. dependency, and what it would take to break free from China’s dominance. 

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The Federal Reserve held rates steady today, while emphasizing that elevated uncertainty has clouded the path forward.  If, when, and how much tariff policy will change in the months to come will play a large part in dictating the next move for the Fed. But until greater clarity arrives, the Fed is happy to watch and wait.

Starting with today’s FOMC statement, there were a few changes worthy of note.  In the very first sentence, the Fed added text that “swings in net exports have affected the data,” which made sense given how the first quarter GDP declined, but all due to a temporary surge in imports. Additional changes to the text noted rising uncertainty in the economic outlook, with the Fed judging risks are higher for both unemployment and inflation – the two parts of the Fed’s mandate.   

We admit this is an incredibly difficult time to forecast, with soft sentiment data moving in negative direction while some hard data on real activity continues to progress.  The remnants of COVID-era spending measures are still echoing through the system, and how the economy will progress in the short term if true progress is made in cutting deficit spending and signing new trade deals is still to be seen. The era of easy everything is over, and while that may not be a welcome transition for many, it’s a necessary transition. Kudos to Chair Powell for stating during the press conference that US debt has been on an unsustainable path. But just how much discomfort the Fed is willing to endure during a period of transition is yet to be seen.

For the time being the Fed is confident that monetary policy is sufficiently restrictive to continue pushing inflation lower, while giving them leeway to wait for further data to allow a cleaner assessment of how the economy, inflation, and employment are impacted by policy out of Washington.  In Powell’s words, “there is no cost to waiting.” And while pressed time and again by reporters to comment on what should be done on the tariff and tax front, Powell – to his credit – simply stated that those are not Fed decisions to make and that they stand ready to act and react to the environment in front of them.  We only wish the Fed would have taken the same hands-off approach during COVID.

Much could happen between now and the next Fed announcement scheduled for June 18.  At the very least, the next meeting will bring updated economic and rate projections from Fed members (the dot plots), and we will have at least a month of full data looking at the early impacts any trade disruptions have brought. Throughout this period of increased uncertainty, we are working harder than ever to dive into the data and identify the trends that we believe are critical to navigating the current environment. From the Monday Morning Outlook, Three on Thursday, Data Watches, and Wesbury 101 videos, our goal is to help bring you clarity on the numbers that matter most.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications: The U.S. trade deficit widened to a record $140.5 billion in March, as exports edged up slightly while imports surged by $17.8 billion. Like January, the jump in imports was driven by businesses rushing to front-run President Trump’s new tariffs. Pharmaceuticals led the way, soaring $20.9 billion in a single month. Because imports subtract from GDP in national accounting, this surge became a major drag on growth. Net trade alone shaved roughly five percentage points off Q1’s growth rate, pulling real GDP down at a 0.3% annualized pace. With tariff pre-buying likely peaking in March, imports should slow and become a positive for real GDP in Q2. In fact, early signs of a sharp import slowdown are already emerging. Vizion, a global container tracking firm, reports that twenty-foot equivalent unit (TEU) bookings from China to the U.S. are down over 40% year-over-year for the weeks of April 14 and April 21, and down 27% for the week of April 28. Overall, U.S. trade volume (exports + imports) is up 18.1% from a year ago—exports are up 6.7%, but imports have climbed 27.1%. Meanwhile, the landscape of global trade continues to shift. China, once the top exporter to the U.S., has fallen to third place behind Mexico and Canada. Also in today’s report, the dollar value of US petroleum exports exceeded imports once again. This marks the 34th consecutive month of the US being a net exporter of petroleum products.

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Implications:  No sign of a recession in April for the US service sector, as the ISM Services index beat consensus expectations and rose to 51.6, signaling continued expansion in the part that drives two-thirds of the US economy.  Looking at the details, April’s change in the indexes were a reversal of the movement in March, with most major measures of activity moving higher.  The index for new orders climbed to 52.3, with respondent comments noting a rising number of companies looking to increase sourcing and manufacturing in the US.  Meanwhile, business activity continued to expand in April but at a slower pace than March, with the index declining to 53.7.  Despite orders and business activity increasing, service companies have taken a cautious stance with their hiring efforts.  The employment index remained in contraction territory for the second month in a row, with an equal number of industries (eight) reporting higher employment versus lower employment in April.  Respondent comments reveal that impacts from cuts on federal government spending and grants are contributing to the hiring freeze among some service companies.  Finally, the highest reading of any category was once again the prices index which rose to 65.1 in April, with seventeen out of eighteen major industries reporting paying higher prices and just one reporting a decline (Arts, Entertainment & Recreation).  The prices index sits at the highest level since the beginning of 2023, but far from the worst during the years following the onset of COVID.  The Federal Reserve is unlikely to move at their meetings this week as it continues to watch how the economy responds to actions out of DC, but we believe the Fed is eyeing further rate cuts in the later part of 2025.   As for the economy, it’s true that tariffs and government spending cuts are impacting, but they have not induced a recession.  The service sector remains a lifeline for growth – for now.

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Noise about tariffs, business uncertainty, a constitutional fight, and a drop in stock prices had already created fear of a recession.  When real GDP declined in the first quarter of 2025, some started to question if a recession is already here.  Let’s take a deep breath and consider the facts.

Yes, real GDP dipped at a -0.3% annual rate in Q1, the first decline for any quarter since 2022.  But the main reason was that trade with other countries accounted for the largest drag on the economy for any quarter since at least 1947, as both consumers and companies loaded up on goods from abroad before higher tariffs kicked in.  Since GDP is designed to measure domestic production, imports are subtracted even though Americans buy them because they were produced abroad.  We aren’t saying GDP is a flawed statistic, we are saying it needs to be viewed correctly.

Real (inflation-adjusted) consumer spending increased at a moderate 1.8% annual rate in the first quarter and real business investment in equipment spiked up at a 22.5% annual rate, neither of which looks recessionary.  We like to track “core” GDP, which is consumer spending, business fixed investment, and home building, but excludes the most volatile categories like government purchases, inventories, and international trade.  Core GDP grew at a 3.0% annual rate in Q1, exactly matching the growth rate of the past year.

So, GDP was not the signal that the headline number suggested.  In fact, when it was released, initially stocks went down only to recover as calmer heads prevailed.  Nonfarm payrolls rose 177,000 last month and are up 144,000 per month so far this year.  And the mix of jobs is much more positive.  In 2023-24, 73% of the increase in payrolls were government, education, health care, and social services jobs.  These jobs are largely driven by government spending policies, especially deficit spending.  In the past three months, that share has dropped to slightly less than half.  In other words, less of the recent job growth is due to government spending expansion.

Another signal that the US wasn’t in recession in the first quarter was that industrial production was up at a 5.4% annual rate while manufacturing rose at a 5.1% annual rate.

Instead, the slippage in real GDP reminds us of the decline in early 2022, when many analysts and investors (as well as conservative political commentators) were quick to declare a recession even though the decline in GDP, like in Q1 this year, was driven by one-off factors like inventories and trade, while the job market and industrial production kept growing.

Nonetheless, while we don’t think the data show a recession yet, the odds of a recession starting in the next year or so are still higher than normal.  We estimate in the range of 40 – 50%.  Why is the recession risk higher than normal?  For one thing, we have yet to fully feel the effects of the tightening of monetary policy in 2022-23 – with both a drop in the M2 measure of the money supply as well as higher short-term interest rates.

At the same time, federal budget hawks have taken over.  In both 2023 and 2024, we saw the most reckless spending of our lifetimes, with the budget deficit running in the range of 6.0 - 6.5% of GDP even as the unemployment rate hovered near 4.0%.  To put this in perspective, the highest deficit under President Regan was 5.9% of GDP when the unemployment rate was 10.0%.  The reckless deficit expansion of the past two years likely masked or hid some of the pain we were eventually going to feel from the tightening of monetary policy.

But now fiscal policy is going in reverse, with the potential to unmask or reveal that pain.  Tariffs are going up, meaning higher receipts, while the part of the federal budget that presidents have the most power to control – non-defense discretionary spending – is being curtailed, including at USAID, the Department of Education, and elsewhere.  This past week the Trump Administration made a budget authority request for non-defense discretionary programs in FY 2026 for $679 billion, which is 32% below the $997 billion the Congressional Budget Office had assumed as recently as January.

This represents a major shift in the spending habits of the federal government and will, if enacted, lead to more resources staying in the private sector.  But, in the very short run, it might also bring some transitory economic pain to those who rely on that spending for their livelihood.  The impact is not immediate.

In the meantime, uncertainty about tariffs might also contribute to a slowdown.  Already, imports are slowing after their surge, and companies are hesitant to re-shore economic activity because the timing and duration of tariffs is unknown.

The bottom line is that it’s unlikely a recession has started yet, but investors should remain alert.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications:  The labor market continued to perform better than expected following “Liberation Day” tariffs, adding more jobs than even the most optimistic forecast by any economics group surveyed by Bloomberg.  Nonfarm payrolls grew 177,000 for the month, and even after factoring in large downward revisions to prior months rose 138,000, which matched consensus expectations.  A large part of the gain came from education and health services, up 70,000.   Meanwhile, jobs at restaurants & bars rose 24,000.  We like to follow payrolls excluding three sectors: government, education & health services, and leisure & hospitality, all of which are heavily influenced by government spending and regulation (that includes COVID lockdowns and re-openings for leisure & hospitality).  In what is probably the best news for April, this “core” measure of jobs rose 73,000, beating the 37,000 monthly average in the past year.  Notably, jobs in the manufacturing sector (which is most affected by tariffs) declined by 1,000 in April. However, manufacturing employment was also revised up by 2,000 in April and is up 5,000 since the beginning of 2025. Meanwhile, civilian employment, an alternative measure of jobs that includes small-business start-ups increased 436,000.  Given these job increases, why did the unemployment rate remain unchanged at 4.2% in April?  Because the labor force (people who are either working or looking for work), rose 518,000.  Other details in today’s report suggested moderate economic growth through April, but reasons for the Federal Reserve to be cautious about cutting short-term interest rates.  Total hours worked increased 0.1% in April and are up 1.5% in the past year.  Add that gain in hours worked to the trend growth rate in productivity (output per hour) of 1.8% per year in the past decade and we are seeing above 3% economic growth.  Meanwhile, average hourly earnings rose 0.2% in April and are up 3.8% in the past year, still higher than the 3.5% we think the Fed would like to see.  Finally, it looks like DOGE continued to make progress in reducing federal government payrolls in April, with jobs falling 9,000. Over the past three months federal employment has dropped by 26,000 (the most outside of the COVID pandemic since the 2013 budget sequestration), and the BLS points out that employees on paid leave or receiving severance aren’t included in these declines. Given the Trump Administration’s goal of reducing the federal workforce, we expect more of this in the months ahead, potentially much more.  That may cause some short-term pain for the US economy, but we expect long-term gains from reducing the size and scope of the federal government, including more jobs gains in the private sector.  In other recent news, cars and light trucks were sold at a 17.3 million annual rate in April, down 3.1% from March but up 7.8% from a year ago, but was likely affected by buyers front running tariffs.

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In this week’s edition of Three on Thursday, we dig into the true state of U.S. manufacturing—a sector often written off with the tired claim that “America doesn’t make anything anymore.” Manufacturing in America didn’t die—it evolved. To help put today’s manufacturing landscape in perspective, click on the
link below.

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Implications:  Activity in the manufacturing sector continued to decline in April, but not as much as the consensus expected. It’s important to remember that before 2025, the manufacturing sector had been limping along for two years: the ISM Manufacturing index was below 50 every single month for 2023-24.  Now, manufacturers must also contend with uncertainty surrounding tariffs (whether they are actually put in place or not, and to what degree), and the resulting changes in supply chains.  That impact is clearly visible in the April data.  Looking at the details of the report, it’s a surprise that despite the headline index ticking down to 48.7 from 49.0, the major measures of activity moved mostly higher.  The overall decline was entirely due to a fall in the production index, as it dropped to 44.0 from 48.3.  Order books were already weak before tariffs, and the business-climate uncertainty that manufacturers now face has pushed this index down to the lowest level since the COVID lockdown months.   Survey comments note that some customers are starting to delay orders until they can understand how new tariffs impact their products and margins.   In turn, manufacturers are responding by adjusting their hiring efforts, as the employment index remains firmly in contraction, with eight out of eighteen industries reporting lower employment in April, versus five reporting higher.  On the supply chain front, respondent comments report of delayed border crossings as terms are renegotiated between buyers and suppliers, compounded by duty calculations that are complex and not completely understood. As a result, the supplier deliveries index rose to a 33-month high of 55.2 in April, signaling much slower delivery times.  However, this is far from the worst we saw during COVID supply chain disruptions.  In other words, supplier bottlenecks are significant, but not as nearly as bad as COVID levels.  Finally, the worst part of the report is that inflation remains a major problem.  Prices paid by companies rose again in April and the pace accelerated, with the index increasing to 69.8. That is the highest index level since the surging inflation of 2022, even as manufacturing stagnates.  Not a good sign for the economy.  In employment new this morning, initial jobless claims rose 18,000 last week to 241,000, while continuing claims jumped 83,000 to 1.916 million, the highest level since late 2021.  We are forecasting that tomorrow’s official Labor Department report will show a nonfarm gain of 145,000, a slowdown from the average pace of 181,000 in the prior six months. In other news this morning, construction spending declined 0.5% in March, as a drop in homebuilding led most other declining categories.

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