As trade tensions have escalated in recent weeks, some fear that Japan and China are “dumping” U.S. Treasuries in an effort to pressure the U.S. by driving up interest rates. We believe that concern is overstated. In this week’s edition of Three on Thursday, we dig into the details of U.S. federal debt ownership.

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Implications:  Existing home sales remained sluggish in March, with broad-based declines across all major regions causing the largest monthly decline since 2022. Sales activity has been characterized by fits and starts since 2022, with any positive upward trend eventually running into a ceiling of around 4.300 million.  Big picture, sales are still well below the roughly 5.250 million annual pace that existed pre-COVID, let alone the 6.500 million pace during COVID.  Affordability remains the biggest headwind to sales, and the good news is that 30-year mortgage rates fell roughly 30 basis points in March.  However, interest rates have begun to climb again recently and are back near 7%, meaning financing costs aren’t likely to deliver a sustained tailwind to sales.  Meanwhile, home prices are rising again with the median price of an existing home up 2.7% from a year ago.  Speaking of price, it looks like the housing market has bifurcated.  While the sales of homes worth $500,000 and above are up in the past year, sales for homes below this threshold are flat or have continued to fall.  On a positive note 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, it also suggests that at the lower end of the price spectrum inflation has priced many Americans out of the existing home market.  Existing home sales also face significant competition from new homes, where in many cases developers are buying down mortgage rates to compete and move inventory.  Finally, 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 19.8% 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) to 4.0 in March, a considerable improvement versus the past few years, but 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.  On the manufacturing front, the Kansas City Fed Manufacturing Index, a measure of factory sentiment in that region, fell to -4 in April from -2 in March.

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Implications:  New orders for durable goods surged in March, but beneath the headline lay a much more subdued picture.  The 9.2% jump in new orders was almost entirely due to the very volatile category of commercial aircraft, so expect a big drop in total orders reported next month.  After reporting a modest 13 planes ordered in February, Boeing reported 192 planes ordered in March.  Through the first three months of the year, Boeing has also reported that deliveries are up 56.6% year-to-date versus 2024.   But, tariff concerns certainly affect these numbers.  Expect these numbers to slow (and cancelations to increase; for example, China) in the months ahead as companies and countries navigate the tariff environment.  Excluding the transportation sector, orders for durable goods were unchanged in March.  Orders rose for primary metals (+0.7%), fabricated metal products (+0.2%), and machinery (+0.1%), but those gains were fully offset by declining orders for computers & electronic products (-1.2%) and electrical equipment (-0.5%).  The most important number in the release, core shipments – a key input for business investment in the calculation of GDP – rose 0.3% in March.  These shipments rose at a 2.5% annualized rate in Q1 versus the Q4 average.  But, adjusting for inflation, little growth will be reported, and while core shipments grew at a healthy pace in March, orders for these items rose a tepid 0.1% after declining 0.3% in February, signaling deliveries will be impacted in future quarters.  The current environment in Washington has elevated uncertainty.  We expect volatility in the data to be the rule rather than the exception for the foreseeable future, as businesses navigate the new policy environment and how it may change the outlook for investment and growth.  In turn, the Federal Reserve will navigate what these changes mean for the path of inflation.  While we don’t expect any movement from the Fed at the meeting in May, we do believe that cuts are on the table for later in the year as economic weaknesses brings the employment side of the Fed’s mandate into more central focus.  In other news this morning, initial jobless claims rose 6,000 last week to 222,000, while continuing claims declined 37,000 to 1.841 million.  These figures suggest moderate job growth in April.

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Implications:  New home sales surprised to the upside in March, beating even the most optimistic forecast by any economics group surveyed by Bloomberg, and rising for the second month in a row.  Looking at the big picture, buyers purchased 724,000 homes at an annual rate, well below the highs of the pandemic and essentially unchanged from 2019.  Looking at the details, most of the gain in March was driven by a 13.6% jump in sales in the South (the largest region) where activity reached the highest level in four years. Though we expect a modest upward trend in sales in 2025, the housing market continues to face challenges. The biggest (and most obvious) is financing costs. While March sales probably benefitted from a temporary dip in mortgage rates, that has recently reversed with the average 30-yr fixed rate back near 7%.  Further, the Fed has recently paused their rate cuts, meaning the housing market is on its own for the time being. One piece of good news for potential buyers is that median sales prices are down 7.5% in the past year, and down 12.3% from the peak in October 2022. The Census Bureau reports that from Q3 2022 to Q4 2024 (the most recent data available) the median square footage for new single-family homes built fell 3.4%. So, it looks like at least part of the drop in median prices is due to smaller, lower-cost homes along with a drop in the price per square foot.  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 280% versus the bottom in 2022. 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.  While the future cost of financing remains a question, lower priced options and an abundance of inventories will help fuel new home sales in 2025. In other recent news, the M2 measure of the money supply grew 0.4% in March and is up 4.1% from a year ago.  This remains below the 6% growth that has been normal over the past few decades, and in combination with recent inflation reports, we think the Fed has room for modest rate cuts (for more on that, see last week’s MMO). Finally, on the manufacturing front, the Richmond Fed index, a measure of mid-Atlantic factory activity, fell to -13 in April from a reading of -4 in March.

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We’ve expected a recession for more than a year now.  Simply put…the Era of Easy Everything is Over.  Expanding deficits and easy money (that have lifted the economy since COVID) are no longer with us.  At the same time, tariff negotiations have created an unbelievable amount of uncertainty.  Add it all up and we expect 0.3% real GDP growth in the first quarter.

Consumers and businesses were front-running tariffs in Q1, trying to get as many goods into the country as soon as possible before higher tariffs took effect.  But if a business is thinking of systematically maneuvering around higher tariffs, by moving operations into the US, they need more certainty about what those tariffs will be and how long those tariffs will last.  Once the rules are set, business will accommodate them.

As a result, it remains to be seen whether economic growth will pick back up in the second quarter.  If not, worse may be ahead.

In the meantime, after two years of artificially boosting growth by expanding the budget deficit to unprecedented peacetime levels when the unemployment rate has hovered near 4%, fiscal policy has suddenly become contractionary, with discretionary spending cuts related to DOGE and otherwise, while tariffs boost tax revenue.

Hence, our forecast of near zero growth in Q1, with one big caveat, which is that the day before the government releases the official GDP report it provides new data on inventories and international trade for March.  Given the volatility of the trade figures, it’s possible we update our forecast substantially that day.

Consumption: Auto sales declined at a 3.0% annual rate in Q1 while “real” (inflation-adjusted) retail sales excluding autos slipped at a 1.3% rate.  However, most of consumer spending is services and real service spending appears up a slow 1.3% pace, bringing our estimate of real consumer spending on goods and services, combined, to a 0.7% rate, adding 0.5 points to the real GDP growth rate (0.7 times the consumption share of GDP, which is 68%, equals 0.5).

Business Investment:  We estimate a 3.6% growth rate for business investment, with gains in equipment leading the way.  A 3.6% growth rate would add 0.5 points to real GDP growth.  (3.6 times the 14% business investment share of GDP equals 0.5).

Home Building:  Residential construction was roughly unchanged in the first quarter, buffeted between a lack of housing supply (which should boost growth) and higher mortgage rates (which should dampen construction).  Home building looks like it was flat, which would mean it neither added to nor subtracted from real GDP growth.

Government:  DOGE and other Trump Administration efforts are cutting back on federal payrolls and transfers to NGOs, but only direct government purchases of goods and services (not government salaries or transfer payments) count when calculating GDP.  We estimate these purchases were up at a 1.2% rate in Q4, which would add 0.2 points to the GDP growth rate (1.2 times the 17% government purchase share of GDP equals 0.2).

Trade:  The trade deficit soared in the first quarter as businesses were busy front-running tariffs.  However, some of the increase in the trade deficit was due to imports of non-monetary gold, which won’t influence GDP.  The remainder, caused by other goods, will be counted.  This forecast may change a great amount when the “advance” report on trade arrives the morning of Tuesday April 29, but for now we’re projecting net exports will reduce the Q1 real GDP growth rate by 0.9 percentage points.

Inventories:  Inventory accumulation looks like it ran at the same slow pace as in Q4, translating into zero net effect on the growth rate of real GDP.

Add it all up, and we get a 0.3% annual real GDP growth rate for the first quarter.  Barely positive, and we will revisit the forecast when we get that crucial report on trade and inventories in eight days.

We do expect government spending to slow in the quarters ahead.  At the same time, monetary policy is no longer easy.  In other words, the jury is out on whether the first quarter is a sign of things to come.  We still think the US has to experience economic pain in order to move to a more sustainable long-term policy environment.  Getting there is creating a great deal of uncertainty.  Stay cautious.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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In this week’s installment of “Three on Thursday,” let’s explore some of the dynamics surrounding the United States dollar. In an era of inflation, massive debt, large deficits, and threats of tariffs, there are persistent rumors circulating that the dollar is at risk of losing its reserve currency status. 

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Implications:  US homebuilding continues to whipsaw as builders deal with all sorts of headwinds, tailwinds, and crosswinds. After unusually cold weather and California fires held back homebuilding in January, new home construction rebounded sharply in February, topping even the most optimistic forecast from any economics group surveyed by Bloomberg.  Then in March, homebuilding contracted by the most in a year, falling 11.4% to a level even lower than the weather-constrained month of January.  Already hamstrung by high home prices and relatively high mortgage rates, builders must now contend with the uncertainty of new tariffs and how they’ll impact their building costs.  Looking at the details, single-family construction led the decline, falling 14.2%, the biggest decline for the category since the COVID lockdown. The overall drop was split amongst regions, with the South and West responsible for the entirety of the decline (homebuilding in the Midwest and Northeast rose in March).  Looking at the trend, home construction has stagnated in recent years, with starts down 1.3% compared to two years ago and hovering around levels reminiscent of 2019.  That said, it appears that part of the reason why homebuilding has lagged is due to builders focusing on completing projects.  Home completions declined 2.1% in March, but the 1.549 million annual pace was faster than all but two months from 2020-2023.  Moreover, completions have run above a 1.5 million pace (our estimation of annual homes needed to keep up with population growth and scrappage) in eleven out of the last twelve months.  With strong completion activity and tepid growth in starts, the total number of homes under construction continues to fall, down 15.2% in the past year.  That type of decline is usually associated with a housing bust, but we don’t see that happening.  With the brief exception of COVID, the US has consistently started too few homes almost every year since 2007.  As a result of the shortage of homes, we think housing is far from a bubble and expect housing prices to continue higher in 2025 in spite of some broader economic headwinds.  In other recent housing news, the NAHB Housing Index (a measure of homebuilder sentiment) ticked up to 40 in April from 39 in March.  On the employment front, initial jobless claims fell 9,000 last week to 215,000, while continuing claims rose 41,000 to 1.885 million.  These figures suggest moderate job growth in April.  Finally, the Philadelphia Fed Manufacturing Index, a measure of factory sentiment in that region, dropped -26.4 in April from 12.5 in March.

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Implications:  March’s report on industrial production doesn’t include any glimpses of what happened after “Liberation Day,” but it shows that factory activity continued to expand despite tariffs going into effect on Canada, Mexico, as well as other specific products. Yes, overall industrial production declined 0.3% in March. However, that entire decline was driven by a 5.8% drop in utilities output that the Federal Reserve points out was the result of warmer than normal weather reducing the demand for home heating. Every other major category increased in March. The manufacturing sector was the biggest source of strength, rising 0.3% to post a fifth consecutive gain.  Looking at the details, auto production jumped 1.2% for the month.  Given the amount of activity that happens in the auto industry across the US southern border, we expect trade negotiations with Mexico to heighten volatility in this sector going forward.  Meanwhile, non-auto manufacturing (which we think of as a “core” version of industrial production) increased a healthy 0.3% in March, and has risen four months in a row. Another notable gain in this “core” measure came from the production in high-tech equipment which rose 0.3% in March, likely the result of investment in AI as well as the reshoring of semiconductor production.  High-tech manufacturing is up 11.3% in the past year, the fastest pace of any major category.  The mining sector was also a source of strength in March, rising 0.6%.  A faster pace of metal and mineral extraction and drilling for new wells more than offset a decline in gas and oil extraction for the month (which was due to normal monthly volatility). Gas and oil production are up 2.4% in past year. Look for an upward trend in activity in this sector in 2025 as the Trump Administration takes a more aggressive stance with permitting.  In other recent news, the Empire State Index, which measures manufacturing sentiment in the New York region, rebounded to -8.1 in April from -20.0 in March.

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Implications:  Retail sales soared in March as consumers scramble to front-run potential tariffs.  Looking at the headline, the 1.4% jump in overall sales was the largest monthly increase in more than two years, led by a 5.3% surge in auto sales (one of the sectors expected to be hit the hardest by tariffs).  Excluding autos, sales rose 0.5%, while previous months’ activity was revised substantially upward.  Building materials – another category expected to be impacted by new tariffs – also showed an outsized gain, rising 3.3%, the largest increase for the category in four years.  Overall, eleven out of thirteen major categories rose in March, with sales at gas stations (-2.5%) and furniture stores (-0.7%) showing the only declines.  We like to follow “core” sales, which excludes the often-volatile categories for autos, building materials, and gas.  That measure rose 0.6% and was up a robust 1.3% including revisions.  Core sales are up 4.6% in the past year but have been slowing in 2025: up at a 3.0% annual rate in the first quarter, even after the March bump from tariff front-running.  The good news is that sales at restaurant & bars – which have been dragging lately – jumped 1.8% in March, matching the largest monthly increase for that category since October 2022.  We watch this category closely since it is the only glimpse we get at services in the retail sales report – the sector that drives two-thirds of the US economy.   As a whole, retail sales are up 4.6% on a year-to-year basis.  However, “real” inflation-adjusted retail sales are up 2.1% in the past year and are still down from the peak in early 2021.  This highlights the ugly ramifications of inflation: consumers are paying higher prices today but taking home fewer goods than they were four years ago.  Going forward, we expect retail sales to remain choppy as consumers try to make heads and tails of what may come next in the constantly shifting environment.  In other recent news, import prices declined 0.1% in March while export prices were unchanged.  In the past year, import prices are up 0.9% while export prices are up 2.4%.

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Quantitative Easing was different during COVID than during the Financial Panic of 2008.  During COVID, M2 growth soared, while it was held back during the Financial Panic by much tighter liquidity controls on banks.  That’s why we were among the first and very few who predicted much higher inflation due to COVID policies.

After that, we remained wary of loosening monetary policy too aggressively because we feared that, in spite of a drop in inflation, inflation remained above the Federal Reserve’s 2.0% target and the embers of higher inflation could be rekindled quickly if the Fed were too hasty.

But recent inflation reports suggest some modest room for loosening monetary policy, including a reduction in short-term interest rates.  In spite of some new tariffs, consumer prices declined 0.1% in March, the largest decline for any month since the early days of COVID.  As a result, consumer prices were up only 2.4% in March versus a year ago and it looks like the Fed’s preferred measure (PCE prices) is up about 2.2% in March compared to a year ago, which is very close to the 2.0% target.

Yes, we are still above 2.0%, but monetary policy operates with long and variable lags.  So, if we maintain a monetary policy tight enough to bring inflation down to 2.0%, and if we also wait until inflation hits 2.0% before ending that tighter monetary regime, then we are almost guaranteeing that inflation will fall short of that 2.0% target for some period of time and could raise medium-term recession risk.

The same M2 measure of money that signaled high inflation several years ago is only up 3.9% in the past year.  By contrast, M2 grew at about a 6.0% annual rate in the ten years before COVID, and that was during a period when PCE inflation averaged 1.5% per year.  In other words, there’s a case to be made that monetary policy should be looser so that M2 could grow faster than it has in the past year.

Unlike some other analysts and investors, we are not concerned that tariffs will lead to much higher inflation, as inflation ultimately depends on monetary policy, not tariff or tax rates.  Yes, tariffs could increase the price of the particular items being tariffed.  But that means less money would be left over to buy other goods and services, so demand – and prices – typically fall, leaving the overall price level roughly the same as it would be in the absence of tariffs.

However, tariffs could temporarily depress economic growth as they leave consumers and businesses with less to spend on domestically produced goods and services.  In theory, tariffs mean producers should shift some of their output toward being made in the US, but in the short-term businesses may balk at such a shift if they think the tariffs will just be repealed soon anyhow.  In other words, if we are going to impose tariffs, it’s better to impose a tariff system that’s sustainable than one that changes year to year, much less week to week or day to day.

On balance, that suggests some modest room for the Fed to cut short-term rates when it meets in May, although we think the Fed will probably kick the can down the road and make the decision in June.

Don’t get us wrong; we are not changing our view that inflation remains a long-term problem that the Fed must be prepared to fight.  We expect inflation to average 2.5%+ in the next ten years, not the 1.5% like it did pre-COVID.  But short-term risks are to the downside, and we think the Fed should temporarily focus on that.

We also think it’s important for the Fed to move gradually.  The US dollar has weakened lately, and, as a result, there is little case for a drastic loosening of monetary policy.  The Fed could let up somewhat on bank regulations and capital requirements, which would help the struggling bond market.  And one or two rate cuts would not be excessive.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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