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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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  New Orders for Durable Goods Rose 0.7% in May
Posted Under: Data Watch • Durable Goods • GDP • COVID-19

Implications:  New orders for durable goods beat consensus expectations in May, with strength across almost all major categories.  With intense scrutiny of every data point on the strength of businesses and consumers, today's surprise to the upside combats concerns that the U.S. economy is already in (or teetering on the precipice of) a recession.  We still have a month to wait before we get our first look at second quarter GDP, and while growth will likely not prove stellar, we don't think it will decline, either.  The underlying details of the durables report showed orders activity was largely positive, with primary metals and industrial machinery the standouts.  Defense aircraft and auto orders rose in May but were partially offset by a decline in orders for commercial airplanes.  The transportation sector is notoriously volatile month-to-month, but stripping that out shows orders still grew 0.7% in May.  Beyond the rise in orders for primary metals (+3.1%) and machinery (+1.1%), orders grew at a healthy clip for computers and electronic products (+0.5%).  Orders for fabricated metals products were unchanged in May while electrical equipment saw orders tick down 0.9%.  Further back in the process, unfilled orders continue to rise, suggesting activity will remain positive as companies battle to keep up with demand that has far outpaced supply.  One of the most important pieces of today's report, shipments of "core" non-defense capital goods ex-aircraft (a key input for business investment in the calculation of GDP), rose 0.8% in May following a 0.8% increase in April.  If unchanged in June, these orders will be up at a 7.5% annualized pace in Q2 versus the Q1 average, and will provide a tailwind to second quarter GDP growth, which is currently tracking around 2% annualized growth following the Q1 GDP decline.  Orders for durable goods have recovered sharply, up 67.9% since the April 2020 bottom and now sit 15.4% above the pre-pandemic high set in February 2020.  We expect business investment will remain a tailwind for GDP growth throughout 2022 as companies continue to reopen and recover from the severe economic consequences of the COVID shutdowns. 

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Posted on Monday, June 27, 2022 @ 2:07 PM • Post Link Share: 
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  We’re Not Already in a Recession
Posted Under: Employment • GDP • Government • Industrial Production - Cap Utilization • Inflation • Markets • Monday Morning Outlook • Fed Reserve • Interest Rates • Spending • Bonds • Stocks
Real GDP declined at a 1.5% annual rate in the first quarter and, as of Friday, the Atlanta Fed's "GDP Now" model projects zero growth in Q2. 

We still think real GDP will turn out to be positive in the second quarter, but if you take the Atlanta GDP Now model at face value, it superficially appears that the odds of having two consecutive quarters of negative growth are close to 50%.  That's important, because two consecutive quarters of negative growth is a rule of thumb that many people use for a recession.

We believe a recession is coming but the US is clearly not in one yet.  In the first five months of the year, manufacturing production is up at a 6.6% annual rate, nonfarm payrolls are up at an average monthly pace of 488,000, and the unemployment rate has dropped to 3.6% from 3.9%.  Meanwhile, in April, both "real" (inflation-adjusted) consumer spending and real personal income (excluding transfers) were at record highs.  If this is a recession, we could use more recessions.

It's also important to recognize that real gross domestic income (real GDI), an alternative measure of economic output, rose at a 2.1% annual rate in the first quarter.  The public pays very little attention to GDI because the government usually takes an additional month to report that data, after GDP is initially released.  But, over time, GDI is just as accurate as GDP in describing the performance of the economy. 

We're not saying everything is fine with the US economy.  Obviously, inflation is taking a huge bite out of people's earnings.  But the debate about whether we're in a recession should be about real economic pain, not academic-style semantics or whether we fit some technical definition. That's the reason the official arbiter of recessions, the National Bureau of Economic Research, weighs jobs, manufacturing, and real incomes, when assessing whether we're in a recession, not just real GDP.

We suspect that some of this debate is political, with some champing at the bit to claim there's a recession because they know it hurts the party of the incumbent president in a mid-term election year. 
Again, we expect a recession, with a lag, after monetary policy gets tight.  And tight it must get in order to wrestle inflation back down toward the Federal Reserve's 2.0% target.  But that means a recession starting in late 2023 or in 2024, not now.

Even more unlikely is the notion that the US is on the cutting edge of a recession like the one in 2008-09.  Bank capital is well above regulatory requirements and we don't have a mark-to-market accounting rule that will generate a "fire sale" in bank assets.  Nor are we about to have a government lockdown of the private sector, like in 2020.

When it comes, the recession will cause economic pain for many.  Recessions always do.  But we expect something like the recessions in 1990-91 or 2001, when the unemployment rate went up about 2.0 to 2.5 percentage points, not like the soaring unemployment of the Great Recession or the 2020 Lockdown. 

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

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Posted on Monday, June 27, 2022 @ 10:33 AM • Post Link Share: 
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  Recovery Tracker 6/24/2022

The table and charts in the Recovery Tracker track high frequency data, which are published either weekly or daily. With 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, June 24, 2022 @ 1:16 PM • Post Link Share: 
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  New Single-Family Home Sales Increased 10.7% in May
Posted Under: Data Watch • Employment • Government • Home Sales • Housing • Inflation • Interest Rates

Implications:  So far, the widely predicted demise of the US housing market has been exaggerated.  Sales of new homes broke a four-month losing streak in May, posting a 10.7% gain to easily beat consensus expectations. Moreover, sales in prior months were revised up as well.  Using April's original reading of 0.591 million, today's headline gain would have been 17.8%.  While it's too early to tell from just one month, the housing market may be beginning to find some footing amid declining affordability, with today's increase marking the first gain so far in 2022.  While rapidly rising prices have been an issue in the housing market throughout the COVID-19 pandemic, 30-year mortgage rates now sit just below 6%, adding to the burden.  Assuming a 20% down payment, the rise in mortgage rates and home prices just since December amount to a 40% increase in monthly payments on a new 30-year mortgage for the median new home. That makes today's headline number even more impressive. Also keep in mind that new home sales are a very timely barometer of the housing market because they are counted when the contract is signed, rather than when the contract is closed, like with existing homes. That said, if the Federal Reserve is hoping to get housing inflation under control through higher interest rates, the progress has been slow.  While median sales price growth has decelerated from a year-over-year peak of 24.2% in August, prices were still up 15.0% in the twelve months ending in May. The main problem is still that buyers are stuck dealing with very few options when it comes to completed homes, and demand remains high.  It's true that overall inventories have been rising recently and now sit at the highest level since 2008.  However, almost all of this inventory gain is from homes where construction has either not yet started or is still underway.  Doing a similar calculation with only completed homes on the market shows a months' supply of a meager 0.6, near the lowest level on record back to 1999.  The good news is that builders have been ramping up construction activity to help meet demand, with the total number of single-family homes under construction at the highest levels since 2006.  In time, that added supply will facilitate more sales while continuing to slow the pace of new home price appreciation.  Ultimately, we think the market will to be able to weather the headwinds of higher mortgage rates in 2022, with sales of new homes only slightly down versus 2021.  In other recent news, initial unemployment claims fell 2,000 last week to 229,000. Meanwhile, continuing claims rose 5,000 to 1.315 million.  Overall, these figures are consistent with continued growth in jobs in June.  On the manufacturing front, the Kansas City Fed Index, which measures factory sentiment in that region, fell to a still solid +12 in June from +23 in May.   

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Posted on Friday, June 24, 2022 @ 11:42 AM • Post Link Share: 
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  Existing Home Sales Declined 3.4% in May
Posted Under: Government • Home Sales • Home Starts • Housing • Inflation • Interest Rates

Implications:  Existing home sales fell for the fourth month in a row in May, hitting the slowest pace since 2020.  Recent volatility shows that the housing market is struggling to find its footing so far in 2022, with falling affordability playing a major role.  The prime culprit recently has been 30-year mortgage rates, which have already risen more than 200 basis points since December and now sit above 6% for the first time since 2008.  Even more notable than the decline in sales in today's report is that despite surging mortgage rates median prices are still climbing, posting a fourth consecutive monthly gain in May. Part of this is just seasonality (prices typically rise heading into the summer buying season), and median price growth in the past year has slowed to 14.8% from a peak of 25.2% in May 2021, but the "reverse wealth effect" the Fed has been looking for has yet to show up in the housing market. Assuming a 20% down payment, the rise in mortgage rates and home prices since December amount to a 45% increase in monthly payments on a new 30-year mortgage for the median existing home. No wonder sales have slowed down! Although the months' supply of existing homes for sale (how long it would take to sell today's inventory at the current sales pace) rose slightly to 2.6 months in May, inventories are still down 4.1% from a year ago, the best way to look at the data given the seasonality of the housing market.  What is really impressive is that despite the lack of options demand remains strong, with buyer urgency so high in May that 88% of existing homes sold were on the market for less than a month.  While sales are clearly under pressure, this is not a repeat of 2008/9. We do not foresee a collapse in home sales even with higher mortgage rates, though it is likely that existing home sales wind up moderately lower in 2022 than 2021.  More inventory is becoming available, though more slowly than we would like (for details see our recent report on housing starts), which will eventually help price gains moderate further.  Also keep in mind that Millennials are now the largest living generation in the US and have begun to enter the housing market in force, which represents a demographic tailwind for sales for the foreseeable future.

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Posted on Tuesday, June 21, 2022 @ 12:14 PM • Post Link Share: 
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  Respect the Bear
Posted Under: GDP • Government • Inflation • Markets • Monday Morning Outlook • Fed Reserve • Interest Rates • Spending • Bonds • Stocks
We became bullish about stocks once mark-to market accounting was fixed in March 2009.  We were also bullish after COVID-19 hit.  We got called "perma-bulls," but as we look back at the low interest rates and healthy profit growth, we don't see any other course to have taken.

We were still bullish at the end of last year, forecasting 5,250 for the S&P 500 and 40,000 for the Dow Jones Industrial Average for 2022.  As always, we used our Capitalized Profits Model to assess fair value for the stock market.  The model starts with the government's measure of economy-wide corporate profits and uses the yield on the 10-year Treasury Note to discount those profits.

The yield on the 10-year Treasury finished last year at about 1.5%, which made the stock market look extremely attractive.  But to be cautious – and because we knew the 10-year Treasury yield was being held back by excessively loose monetary policy – we used a 2.5% yield to discount profits, instead.  Using a 2.5% yield suggested fair value for the S&P 500 was 5,250, which became our forecast for the market at the end of 2022.

Yes, we were also forecasting high inflation and knew monetary policy would eventually have to get tight, but we thought the Fed would be very slow in shifting toward a more appropriate monetary policy.
By early May, with the Fed getting more assertive and the 10-year Treasury yield at about 3.1% (well above our "cautious" 2.5%), we reconsidered our stock market forecast and downgraded it to 4,900 for the S&P 500.  Our thinking was that although the Cap Profits Model was saying we were already at fair value, that the Fed would still be relatively loose and a recession was further away than most investors thought.  In turn, the lack of a near-term recession would allow equities to climb a wall of worry.

But, given the recent hastening by the Fed in the pace of rate hikes and policymakers' lack of focus on what they really need to do — a targeted and persistent reduction in M2 growth — we no longer think equities are going to reach a new high (an S&P 500 north of 4800) until one of two things happens.

The first, and much more likely, possibility is that the Federal Reserve eventually gets monetary policy tight enough to bring inflation down toward its 2.0% target, which, in turn, also induces a recession, probably not this year, more likely in late 2023 or 2024.  In that scenario, a new bull market would start sometime during the recession, once investors start to grow more confident about the recession ending soon.

The second, and less likely, possibility is that the Fed pulls off a soft-landing, in which case a bull market would start once investors become more confident the Fed has pulled it off.  We'd love to see this second scenario play out, but don't expect it.

Either way, we don't expect the S&P 500 to hit a new all-time high, above the old high of 4,797, anytime soon.  Instead, until one of our two scenarios plays out – a recession or the realization the Fed has pulled off a soft-landing – US equities are likely to be in a trading range with potential bear market rallies that come and go.  At current prices, equities could easily rally from here, but if a recession is eventually coming that rally will not last.

It's now clear that the Fed is raising short-term interest rates much faster than anyone thought at the start of the year. And the 10-year yield continues to rise. But the problem with simply raising rates to try to tighten monetary policy is that the way the Fed implements monetary policy doesn't directly lead to shifts in the money supply like it used to. 

Before 2008, if the Fed wanted to tighten monetary policy it would sell bonds and drain reserves from the banking system.  Now the Fed thinks it can control monetary policy by setting the interest rate it pays banks on reserves.  In other words, higher short-term rates don't automatically mean slower growth in the money supply.  With so many excess reserves in the banking system, the money supply is still more likely to grow than shrink.

The best news we could get is that the Fed starts talking less about short-term interest rates and more about where it would like to see growth in the money supply during the next few years.  It's the rapid growth in the money supply that got us into the inflation mess and it's slower growth in M2 that will get us out of it by bringing inflation back down.  That's why the most important day in June is not June 15, the day of the last meeting and the 75 bp rate hike decision; it's June 28, when the Fed next reports M2 for May. 

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

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Posted on Tuesday, June 21, 2022 @ 9:34 AM • Post Link Share: 
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  Recovery Tracker 6/17/2022

The table and charts in the Recovery Tracker track high frequency data, which are published either weekly or daily. With 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, June 17, 2022 @ 11:19 AM • Post Link Share: 
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  Industrial Production Increased 0.2% in May
Posted Under: Autos • Data Watch • Employment • GDP • Government • Industrial Production - Cap Utilization • Inflation • Retail Sales • COVID-19

Implications:  Industrial activity continued its V-shaped recovery in May, rising for the fifth month in a row, though by less than consensus expectations. Looking at the details, today's report was a mixed bag. While overall industrial production posted a gain, the manufacturing sector reported a small decline in activity in May.  This was driven by manufacturing outside the auto sector where activity fell 0.1%, which more than offset the 0.7% increase in auto manufacturing. While it's too early to tell in the data, there has been a trend recently with Americans shifting their consumption preferences back towards services and away from goods, which could ultimately lead factories to taper back production.  Meanwhile, the mining sector (think oil rigs in the Gulf) continued to make strong progress, rising 1.3% in May.  We expect continued gains from this sector in the months ahead, with oil prices currently above $110 a barrel, incentivizing new exploration.  Unfortunately, there is still no sign of the federal government lending a hand on the energy front, even with the political kryptonite of inflation raging. For example, the Biden Administration recently blamed high prices at the pump on price gouging rather than offering regulatory relief or approving new leases to help spur along additional production.  The good news is that capacity continues to come back online despite this, with Baker Hughes reporting that the total number of oil and gas rigs in operation in the US is rapidly approaching pre-pandemic levels.  Finally, the utilities sector, which is volatile from month to month and largely dependent on weather, rose 1.0% in May.  Overall, despite the shift back towards services, we expect a continued upward trend in industrial production in 2022 with demand continuing to outstrip supply.  For example, this report puts industrial production 4.3% above pre-pandemic levels.  Meanwhile, the report out earlier this week on retail sales showed that even after adjusting for inflation, "real" retail sales are up 13.6% over the same 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 at a record high and more than double pre-pandemic levels.  This mismatch between supply and demand shows why inflation remains uncomfortably high.

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Posted on Friday, June 17, 2022 @ 11:11 AM • Post Link Share: 
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  Housing Starts Declined 14.4% in May
Posted Under: Data Watch • Employment • GDP • Government • Home Starts • Housing • Interest Rates • COVID-19

Implications:  Housing starts posted the largest monthly decline since the early days of the pandemic in May as builders continued to navigate a challenging housing market characterized by the highest mortgage rates since 2008, labor shortages, and ongoing supply-chain issues.  That said, part of today's 14.4% headline decline was the result of April's reading on construction being revised up to the highest level since 2006. Without that upward revision, May's decline would have been a more modest (though still significant) 10.2%. Looking at the details, both single-family and multi-unit construction contributed to the drop in May. It's clear developers are becoming more cautious about future demand for new projects with 30-year mortgage rates nearing 6%. However, it also makes sense to slow down the pace of starts given how many projects are currently sitting in the pipeline. The number of homes already under construction is at the highest level on record back to 1970.  Moreover, the gap between the number of units under construction and the number of completions of new homes remains at record high levels back to 1970s as well. These figures illustrate a slower construction process due to a lack of workers and other supply-chain difficulties.  In this context, it's not surprising to see new building permits fall 7.0% in May.  The backlog of projects that have been authorized but not yet started is currently sitting just below the record high since the series began back in 1999. With plenty of future building activity waiting to get underway as other projects are finished, and given that residential investment is counted in GDP when units are completed, housing can continue to be a tailwind for economic growth even with a slowdown in the headline pace of housing starts given current conditions. Builders are still looking to boost the near record-low levels of inventory to satisfy buyers, and as Millennials continue to enter the housing market as the now largest living generation. In other recent housing news, the NAHB Housing Index, which measures homebuilder sentiment, declined to 67 in June from 69 in May. While this reading remains elevated from a historical standpoint, it is clear supply-chain issues and rising mortgage rates are continuing to have a negative impact, which has pushed this index to a two-year low. In other news this morning, initial unemployment claims fell 3,000 last week to 229,000. Meanwhile, continuing claims rose 3,000 to 1.312 million. Overall, these figures are consistent with continued growth in jobs in June. Finally, in manufacturing news this morning, the Philadelphia Fed Index, a measure of factory sentiment in that region, fell to -3.3 in June from +2.6 in May.

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Posted on Thursday, June 16, 2022 @ 12:15 PM • Post Link Share: 
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  Fed Goes Bigger
Posted Under: Employment • GDP • Government • Inflation • Markets • Research Reports • Fed Reserve • Interest Rates • Spending • Bonds • Stocks

The Federal Reserve raised rates by three-quarters of a percentage point (75 basis points) today, the most at any meeting since 1994 and exactly the move Chairman Jerome Powell was dismissive about in early May after the last meeting.  As a result, the target for the federal funds rate is now 1.50 – 1.75%, and it's headed higher.  At the post-meeting press conference, Powell made it clear that the Fed doesn't expect 75 bp rate hikes to become "common," but a rate hike in the 50 – 75 bp range should be expected at the next meeting in July. 

The "dot plot" from the Fed, which is released every three months and which shows the path monetary policymakers expect the funds rate to take, shows a much steeper pace of rate hikes than the dot plot released back in March.  Earlier this year, the dot plot suggested the funds rate would finish 2022 around 1.875%; now the Fed suggests it will finish around 3.375%.  That's an additional 150 bps.  Perhaps more important: every single Fed policymaker thinks the funds rate will finish this year above 3.00%.  For 2023, the median policymaker projects the funds rate will finish at 3.625%, before gradually starting to decline in 2024 and beyond.

Notably, the Fed downgraded its real GDP growth forecast for this year to 1.7% versus a prior estimate of 2.8%.  Growth in 2023-24 was revised down slightly.  Meanwhile, the Fed increased its estimate for PCE inflation this year, to 5.2% from 4.3%, but slightly revised down its forecast for inflation in 2023-24.  We believe the Fed's inflation forecasts for 2023 and 2024, 2.6% and 2.2%, respectively, are ridiculously low. On net, the Fed downgraded its expectations for nominal GDP growth (real GDP growth plus inflation), which is hard to square with increasing the path for short-term interest rates unless it's seen as a major admission of past policy mistakes and that the Fed knows it is well behind the inflation curve. 

Also of note: the Fed removed language from its last statement in May that it expects the "labor market to remain strong."  This is consistent with the new Fed economic projections, which shows that the unemployment rate, now 3.6%, should finish the year at 3.7% and then go up 0.2 percentage points in each of the next two years.  However, it could also be a hint that the Fed knows fighting inflation may eventually take a set of policies that generate a recession. 

In our view, the next important date to watch for the Fed is not the next meeting in late July, it's June 28, when the Fed releases figures on the M2 measure of the money supply for May.  M2 declined in April, but we think that may have been related to very high tax payments that month.  Wrestling inflation back down will require a persistently slow pace of M2 growth for at least the next couple of years.  With regard to quantitative tightening, the Fed will stick to its current schedule of reducing the balance sheet by $47.5 billion per month until September, when that pace will double.

There was one dissent at today's meeting, from Kansas City Bank President Esther George, who preferred an increase of 50 bps rather than 75 bps. 

The bottom line is that it's good the Fed is now more aware of the enormity of the inflation problem it has created, although it is still too optimistic at how quickly it will get it back under control.  It's now serious about raising rates.  Another big step would be to start to release money supply figures on a weekly basis, like it used to, so everyone can see the progress it's making in closer to real time. 

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

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Posted on Wednesday, June 15, 2022 @ 4:22 PM • Post Link Share: 
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