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   Brian Wesbury
Chief Economist
 
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   Bob Stein
Deputy Chief Economist
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  COVID-19 Tracker 1/24/2022
Posted Under: COVID-19

 
With the recent emergence of the Omicron variant, we continue to hear about school closings, mask mandates, potential shutdowns, vaccine mandates, vaccine effectiveness, the list goes on and on. The vaccines have clearly led to a lower overall level of deaths, and that represents considerable progress. However, this is not just a disease of the unvaccinated, and the shattering of daily case records suggest previously acquired immunity may not prevent infection from the Omicron variant. There are still many questions out there, and it's important to follow the data closely.

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Posted on Monday, January 24, 2022 @ 4:36 PM • Post Link Share: 
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  The 2021 Finish: Fast Growth, High Inflation
Posted Under: Autos • GDP • Government • Housing • Inflation • Markets • Monday Morning Outlook • Retail Sales • Trade • Spending • Bonds • Stocks • COVID-19
When fourth quarter GDP data is released later this week, it will show that 2021 finished on a high note.  Unfortunately, the high note included not only strong economic growth but also rapid inflation.  This shouldn't be a surprise; it's what you get when you mix a huge surge in government spending with very loose monetary policy.

At present, we estimate that real GDP grew at a 5.7% annual rate in the fourth quarter.  If we're right, then real GDP grew 5.2% in 2021 (Q4/Q4), the fastest pace for any calendar year since the Reagan Boom in 1984.  However, that rapid growth follows a 2.3% contraction in 2020.  As a result, real GDP at the end of last year was up only 1.4% annualized versus the end of 2019 (the last quarter before COVID).  That's slower than the pre-COVID trend in economic growth, which means that in spite of the fastest growth in decades last year, the economy remains smaller than it would have been if COVID and all the related lockdowns hadn't happened.  Glass half-full, glass half-empty.

The same can't be said about inflation, which is clearly higher than the pre-COVID trend.  We estimate that GDP prices rose at a 5.9% annual rate in the fourth quarter, which would bring the 2021 (Q4/Q4) increase to 5.6%, the highest inflation for any calendar year since 1981.  That follows a moderate 1.5% gain in 2020.

Bear in mind that we get a report on Wednesday that will tell us about inventories and international trade in December, and those figures may change our projections a little.  But, as of now, here's how we get to our 5.7% real GDP growth forecast for the fourth quarter. 
 
Consumption:  Car and light truck sales fell at a 15.5% annual rate in Q4, largely due to continued supply-chain issues.  However, "real" (inflation-adjusted) retail sales outside the auto sector rose at a 1.0% rate and it looks like real services spending should be up at a solid pace.  Putting it all together, we estimate real consumer spending on goods and services, combined, increased at a moderate 2.0% annual rate, adding 1.4 points to the real GDP growth rate (2.0 times the consumption share of GDP, which is 69%, equals 1.4).

Business Investment:  The fourth quarter should show slight growth in both business investment in equipment as well as commercial construction, while investment in intellectual property rose at a typically strong rate.  Combined, business investment looks like it grew at a 5.3% annual rate, which would add 0.7 points to real GDP growth.  (5.3 times the 13% business investment share of GDP equals 0.7).

Home Building:  Residential construction looks like it slowed slightly in the fourth quarter. That's not due to less demand – sales are trending higher and inventories remain very low – but instead reflects supply-chain issues and lingering problems finding willing workers.  We estimate a contraction at a 4.3% annual rate in Q4, which would cut 0.2 points from real GDP growth.  (-4.3 times the 5% residential construction share of GDP equals -0.2).

Government:  Remember, only direct government purchases of goods and services (and not transfer payments like unemployment insurance) count when calculating GDP.  We estimate federal purchases grew at a 1.1% annual rate in Q4, which would add 0.2 points to real GDP growth.  (1.1 times the 18% government purchase share of GDP equals 0.2). 

Trade:  Imports and exports have both recovered but imports have recovered faster, which should result in a slightly larger trade deficit in Q4.  At present, we're projecting that the increase in imports relative to exports will subtract 0.1 points from real GDP growth in Q4.

Inventories:  Inventories look like they finally started surging in Q4.  Inventories are still very low, but they're moving in the right direction.  We estimate that the surge will add 3.7 points to real GDP growth.

Add it all up, and we get a 5.7% annualized real GDP growth for the fourth quarter.  Look for continued growth in 2022, but not nearly as fast, as the artificial "sugar high" from excessive government spending runs its course.

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist  
 

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Posted on Monday, January 24, 2022 @ 12:10 PM • Post Link Share: 
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  Recovery Tracker 1/21/2022
Posted Under: Bullish • COVID-19

 
The table and charts in the Recovery Tracker track high frequency data, which are published either weekly or daily. With most states reopening their economies and widespread distribution of COVID-19 vaccines, these indicators show continued improvement in economic activity. It won't improve in a straight line, but the trend should remain positive over the coming months and quarters. The charts in the Recovery Tracker highlight where the high frequency data indicators were from 2019 to 2022.

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Posted on Friday, January 21, 2022 @ 3:11 PM • Post Link Share: 
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  Existing Home Sales Declined 4.6% in December
Posted Under: Bullish • Data Watch • Home Sales • Housing • Inflation

 
Implications: After posting three consecutive gains, existing home sales took a breather in December.  However, even though sales ended the year on a weak note, looking at all of 2021 shows a healthy picture. Overall, 6.12 million existing homes were sold during the year, the highest calendar-year level since 2006 and an 8.5% gain over 2020.  This is doubly impressive given the current lack of supply in the market.  The number of listed, but unsold, existing homes was 910,000 in December, an all-time low going back to 1999.  Our expectation is that listings will move upward in 2022, at least on a seasonally adjusted basis, as virus fears fade in the Spring and sellers feel more comfortable showing their homes.  Meanwhile, the months' supply of existing homes for sale (how long it would take to sell today's inventory at the current sales pace) fell to 1.8 months in December, also a record low back to 1999.  Despite the ongoing shortage of listings, there is still significant pent-up demand from the pandemic, with buyer urgency so strong in December that 79% of existing homes sold were on the market for less than a month.  The combination of strong demand and sparse supply has pushed median prices up 15.8% in the past year, but the good news is that price gains have decelerated since hitting a year-to-year gain of 23.6% in May.  Looking forward to 2022, we expect another solid year as more inventory becomes available and price gains moderate.  Millennials are now the largest living generation in the US and have begun to enter the housing market in force, making up over 50% of new mortgage issuance for the first time in 2019. This represents a demographic tailwind for sales for the foreseeable future.  In other news this morning, initial unemployment claims rose 55,000 last week to 286,000.  Meanwhile, continuing claims increased 84,000 to 1.635 million.  Finally, on the manufacturing front, the Philadelphia Fed Index, a measure of factory sentiment in that region, rose to +23.2 in January from +15.4 in December. 

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Posted on Thursday, January 20, 2022 @ 11:37 AM • Post Link Share: 
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  Housing Starts Increased 1.4% in December
Posted Under: Bullish • Data Watch • Home Starts • Housing • Inflation • COVID-19

 
Implications:  Home building finished 2021 on a strong note, rising for a third consecutive month to end the year very close to the pandemic-era high-water mark.  Looking at 2021 as a whole, 1.598 homes were started, the fastest since 2006 and the 12th straight annual gain.  This represents a significant achievement because the US needs roughly 1.5 million housing starts per year based on population growth and scrappage (voluntary knockdowns, natural disasters, etc.), and 2021 was the first year in the aftermath of the 2008/9 recession that has crossed that threshold.  For 2021 as a whole, single-family starts were up 12.3% while multi-family starts rose 20.0%.  But for December alone, multi-family was the only source of strength, rising 10.6% while single-family slipped 2.3%.  It looks like developers finished the year by shifting some resources away from single-family homes and toward larger apartment buildings in response to rapidly rising rents as some people move back into big cities and the eviction moratorium ends.  Zillow estimates that rental costs for new tenants are up 13.9% in the year ending in December and Apartmentlist.com estimates they have risen an even faster 17.8%, easily exceeding typical gains in the 3.0 – 4.0% range.  Recent distributional effects aside, housing construction remains healthy.  While the monthly pace of activity will ebb and flow as the recovery continues, we expect housing starts to trend upward in the next couple of years.  Builders still have a huge number of permitted projects sitting in the pipeline waiting to be started.  In fact, the backlog of projects that have been authorized but not yet started is currently the highest since the series began back in 1999.  Meanwhile, permits for new building projects rose 9.1% in December, the largest monthly gain in seventeen months, demonstrating that builders see even more demand on the horizon. With plenty of future building activity in the pipeline, builders looking to boost the inventory of homes and meet consumer demand, and as more Millennials finally enter the housing market, it looks very likely construction will move higher in 2022.  In other recent housing news, the NAHB Housing Index, which measures homebuilder sentiment, declined slightly to 83 in January from 84 in December.  However, these readings remain near historical highs, signaling robust optimism from developers.  In recent news on the manufacturing front, the Empire State Index, a measure of New York factory sentiment, declined unexpectedly to -0.7 in January from 31.9 in December.  Most of this is due to short-term factors surrounding the outbreak of Omicron cases in the region.  Look for a rebound in the months ahead.

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Posted on Wednesday, January 19, 2022 @ 12:26 PM • Post Link Share: 
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  Who Gets the Blame for Inflation
Posted Under: CPI • GDP • Government • Inflation • Markets • Monday Morning Outlook • Fed Reserve • Interest Rates • Spending • Bonds • Stocks • COVID-19
Consumer prices rose 7.0% in 2021, the largest increase for any calendar year since 1981.  As a result, politicians across the political spectrum are working overtime to find someone to blame and attack.

Some politicians on the left are blaming "greedy" businesses for inflation.  But we find this explanation completely ridiculous.  Of course, businesses are greedy, in the sense that they're run by people who are free to maximize their earnings! 

But businesses are no greedier today than they were before COVID.  In the ten years before COVID, the consumer price index increased at a 1.8% annual rate; in the twenty years before COVID, the CPI rose at a 2.1% annual rate.  Both figures are a far cry from 7.0%.

Those blaming greedy businesses for higher inflation have no rational explanation for why businesses somehow missed all the opportunities to raise prices faster in previous decades but suddenly had a "eureka moment" and decided to do so in 2021.  Under this economically illiterate theory, think of all the profits they've voluntarily foregone for decades.

Meanwhile, think about the rapid increase in workers' pay in 2021, when average hourly earnings rose 4.7%.  Did workers suddenly become greedier, too?  Is all this greed contagious?  Can we stop it by wearing masks?  What does the CDC have to say?

But the political left is not alone in misunderstanding higher inflation.  Some politicians on the right are saying the inflation is due to the huge surge in COVID-related government spending and budget deficits.  Part of this is likely tactical: by blaming government spending and deficits, they can reduce the odds of passing the Biden Administration's Build Back Better proposal, which they'd like to see defeated.

What they're missing is that there is no consistent historical relationship between higher spending, larger deficits, and more inflation.  Yes, inflation grew in the late 1960s after the introduction of the Great Society programs.  But government spending also soared in the 1930s under Roosevelt's New Deal, without a surge in inflation.  Budget deficits soared in the early 1980s and inflation fell.  The Panic of 2008 led to a surge in government spending and deficits and inflation remained tame.

So, if it's not greed or government spending, by itself, then what is causing higher inflation?  We think it's loose monetary policy.  The M2 measure of the money supply has soared since COVID started.  That is the (not-so-secret) policy ingredient that has converted extra government spending and deficits into more inflation rather than higher interest rates.

That, in turn, makes it important to follow the path of monetary policy this year and beyond.  In recent weeks, a number of Fed policymakers have hinted at rate hikes starting in March, including Mary Daly, the president of the San Francisco Fed and considered a dove.  Rule of thumb: when the doves get hawkish and start hinting at rate hikes, it's time to believe the hints. 

The futures market in federal funds is pricing in four rate hikes this year.  For now, we think the most likely policy path is three hikes – 25 basis points each: in March, June, and December, with a hiatus for the mid-term election season.

In addition, we think the Fed finishes up Quantitative Easing (QE) in March and starts Quantitative Tightening (QT) around mid-year.  The easiest and most straightforward way for the Fed to do QT would be by selling Treasury and mortgage-backed securities to the banks and having the banks buying them send their reserves back to the Fed. The Fed can then erase those reserves from its balance sheet.  That would result in the Fed holding fewer bonds as assets while being liable for fewer reserves, reducing its overall balance sheet.  Instead, the Fed will probably take a more complicated path of not rolling over some assets when they mature, which means the Fed will have to coordinate its operations with the Treasury Department.

The key to remember, though, is that a few rate hikes and some modest QT will still leave monetary policy too loose.  "Real" (inflation-adjusted) short-term rates will still be negative while actual short rates remain well below the trend in nominal GDP growth (real GDP growth plus inflation).

The Fed has its work cut out for it.  Its goal is to execute a reduction in inflation while sticking a soft-landing for the economy.  A year from now, we'll have a much better idea whether it can meet both these goals.   

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist 


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Posted on Tuesday, January 18, 2022 @ 9:47 AM • Post Link Share: 
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  Recovery Tracker 1/14/2022
Posted Under: Bullish • COVID-19

 
The table and charts in the Recovery Tracker track high frequency data, which are published either weekly or daily. With most states reopening their economies and widespread distribution of COVID-19 vaccines, these indicators show continued improvement in economic activity. It won't improve in a straight line, but the trend should remain positive over the coming months and quarters. The charts in the Recovery Tracker highlight where the high frequency data indicators were from 2019 to 2022.

Click here to view the report
Posted on Friday, January 14, 2022 @ 4:15 PM • Post Link Share: 
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  Industrial Production Declined 0.1% in December
Posted Under: Autos • Data Watch • Government • Industrial Production - Cap Utilization • Spending • COVID-19

 
Implications:  US industrial activity moderated slightly to end 2021, following gains in October and November as factories came back online after temporary disruptions from Hurricane Ida.  The slowdown in activity was broad-based in December, with most major categories posting declines.  Looking at the details, the utilities sector led the headline index lower, down 1.5%, due to the warmest December weather in the "lower 48" since at least 1921 (when records started).  Meanwhile manufacturing production – both including and excluding autos – dropped in December.  A portion of the slowdown can be attributed to rising COVID cases, which made staffing factory floors increasingly difficult.  As the Omicron wave passes, expect activity to trend higher once again.  Business inventories remain lean, order backlogs are elevated, and demand continues to outstrip supply.  As supply chains gradually ease, there is plenty of ground for production to make up just to get things back toward "normal."  The mining sector (think oil rigs in the gulf) was one bright spot in December, rising 2.0% on the month and up at a 30.6% annualized rate in the fourth quarter. We expect this sector to be a tailwind for overall industrial production in the months ahead as activity still remains 6.5% below pre-pandemic levels and has lagged the recovery elsewhere.  Looking at things more broadly, today's decline puts industrial production 0.6% above pre-pandemic levels. This means production still has a long way to go to meet current demand.  For context, this morning's report on retail sales showed that even after adjusting for inflation, "real" retail sales are up 10.1% over that same time period.  Ongoing issues with supply chains and labor shortages are hampering a more robust rise in activity, with job openings in the manufacturing sector currently more than double pre-pandemic levels.  This mismatch between supply and demand, shows why inflation has accelerated so sharply.  Normally easy money takes 18-24 months to show up as inflation. As supply chains heal inflation will moderate, but while supply chain issues are transitory, excess M2 growth is not. Look for industrial production to bounce back in the months ahead.   

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Posted on Friday, January 14, 2022 @ 11:56 AM • Post Link Share: 
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  Retail Sales Declined 1.9% in December
Posted Under: Data Watch • Retail Sales • COVID-19

 
Implications: Retail sales missed the mark by a wide margin in December, falling 1.9% as most major categories declined.  A number of factors contributed to the drop in sales in December.  First, consumers pulled forward some of their Christmas shopping into October (when sales rose a whopping 1.8% for the month) as fears of shortages were on everyone's mind. Retail sales in the fourth quarter as a whole were up 2.1% versus the third quarter and up 17.1% versus a year ago.  Second, rising Omicron cases across the country (temporarily) affected both consumers' ability to go out, and companies' abilities to staff stores.  And third, retail sales were pushed up massively during the government spending and money-printing bonanza of 2020 and early 2021, while at the same time consumers couldn't engage portions of the service sector, pushing even more activity towards buying goods.  That means it was always going to be difficult for sales to continue to rise near the same pace once checks stopped flowing.  This will be important to remember across 2022; a flat to downward trend in retail sales is simply activity coming back down toward normal.  All that said, overall sales are still up a robust 16.9% in December compared to a year ago and have risen 19.2% since February of 2020.  Looking at the details of today's report show activity slowed virtually across the board, with outsized declines among non-store retailers (think online shopping).  Gas station sales declined, which was to be expected given the drop in national gas prices in December.  "Core" sales, which exclude the most volatile categories of autos, building materials, and gas, fell 2.7% in December, but remain up 17.0% from a year ago.  In other words, even with a weak December report, retail sales are running much hotter than they would have had COVID never happened, even as the level of output (real GDP) is still running lower than it would have been in the absence of COVID.  While areas like online shopping, sporting goods stores, and gas stations have had above-trend growth since COVID began, areas like restaurants & bars weren't back to pre-COVID levels until April of 2021, and the winter rise in COVID cases is bringing volatility to their sales once again.  In the months ahead, the path of retail sales will be a battle between a number of opposing factors.  Rising wages, jobs, and inflation will all be tailwinds for retail sales, while the waning of the temporary and artificial boost from "stimulus" checks and other government benefits will be headwinds.  In other news this morning, import prices fell 0.2% in December while export prices declined 1.8%.  However, in the past year, import prices are up 10.4%, while export prices are up 14.7%.  Expect prices to move higher in the months ahead as Omicron wanes and monetary policy – both here and abroad – remain overly loose.

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Posted on Friday, January 14, 2022 @ 11:39 AM • Post Link Share: 
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  The Producer Price Index (PPI) Rose 0.2% in December
Posted Under: Data Watch • Employment • Government • Inflation • PPI • Fed Reserve • Spending • COVID-19

 
Implications:  Producer prices rose a moderate 0.2% in December, the smallest increase in nearly a year and less than the consensus expected 0.4%.  However, this doesn't mean the inflation scare is over; it just means that commodity prices temporarily fell in December and the PPI is more heavily weighted toward commodities than consumer prices.  Commodity prices have since rebounded, so look for a faster increase in the PPI next month.  In the meantime, producer prices were up 9.7% in the year of 2021, the largest calendar-year increase since this series was first calculated in 2010.  In terms of details for December, services led the overall index higher, rising 0.5% for the month, where over half of the broad-based advance can be traced to margins received for final demand trade services. Increasing prices for services were largely offset by prices for goods, which declined 0.4% in December, the first drop for the category since April 2020.  The volatile energy and food categories were drivers of the decline in goods prices, falling 3.3% and 0.6%, respectively.  A major factor for the decline in goods prices was the index for gasoline, which moved down 6.1%.  Stripping out the food and energy categories, "core" prices still rose 0.5% in December and are up 8.3% in the past year.  It simply doesn't matter how you cut it or which inflation gauge you prefer, they all show inflation running well above where the Fed said it would at the start of 2021.  Will that trend continue in 2022?  While for years after the financial crisis the question from many was whether the Fed could induce even 2% inflation, the question now is whether the Fed will be able to get back down or near 2% in the foreseeable future. And while producers are still hampered with supply chain woes, demand has been amplified by a M2 money supply that is 39% above pre-COVID levels; Fed policymakers have their work cut out for them. In employment news this morning, initial unemployment claims rose 23,000 to 230,000 last week. Meanwhile, continuing claims fell 194,000 to 1.559 million, the lowest since 1973.

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Posted on Thursday, January 13, 2022 @ 11:15 AM • Post Link Share: 
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These posts were prepared by First Trust Advisors L.P., and reflect the current opinion of the authors. They are based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.
 
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