Implications: Both income and consumption rose in June after surging in May, while prices fell for the first time since 2022.  Starting with income, growth was led by private sector wages and salaries which rose 0.2% (up 4.7% in the past year) and government transfer payments which were up 0.5% in June (+4.3% from a year ago).  While the 4.7% increase in private sector wages over the past year sounds decent on paper, remember that inflation is up 3.7% over the same time period, meaning purchasing power is little changed.  On the spending side, personal consumption rose 0.3% in June, led by health care, motor vehicles, and financial services.  Collectively, goods spending (which includes energy costs) rose a modest 0.1% in June, while spending on services increased 0.4%.  The personal saving rate — which tracks how much of after-tax income is not consumed — fell to 2.7% in June, marking the lowest reading since the COVID-era in 2022 (and before that during the Great Financial Crisis in 2008!).  This low level of saving allows for more spending today, but isn’t sustainable long-term.  Meanwhile, the inflation picture eased temporarily as the conflict with Iran was on pause and oil prices eased. PCE prices – the Fed’s preferred inflation metric – fell 0.1% in June, while the year-ago reading moderated to 3.7%.  “Core” prices, which strip out the volatile food and energy categories, rose 0.1% in June, with the year-ago comparison now at 3.3%, a notable uptick from the 2.8% pace for the twelve-months ending in June 2025.  The Fed will be watching these data closely under their new Fed Chair, while trying to determine how monetary policy – which operates with a lag – should respond as inflation continues to ebb and flow.  We expect the Fed will remain on pause for the foreseeable future as they wait for the fog to clear and a better picture of sustained inflation pressures to come into view.  In recent housing news, the FHFA index rose 0.3% in May and is up 2.2% in the past year, while the national Case-Shiller index was unchanged in May, but is up 1.1% in the past year. In other news, the Richmond Fed index, a measure of mid-Atlantic factory activity, ticked up to 5 in July from 4 in June.

Click here for a PDF version

Implications: Economic growth was mediocre in the second quarter, with inflation running hot due to the Iran War.  Real GDP grew at a 1.5% annual rate in Q2, lagging the consensus expected 2.0% as well as the 2.1% growth rate in Q1.  Personal spending, which grew at a 3.2% rate, was the key driver for economic growth in the second quarter.  However, the AI/data center build-out also remains a very important factor.  Data center construction grew at a 15.2% rate, business investment in information processing equipment grew at an 8.3% pace, investment in software grew at an 11.4% rate, and R&D was up at a 7.5% pace.  Without this build-out, real GDP would have grown at less than a 1% pace.  By contrast, the best news in today’s report was that Core Real GDP – which includes consumer spending, business fixed investment, and home building, and excludes more volatile categories like government purchases, inventories, and international trade – grew at a 3.9% rate in the second quarter, the fastest pace in more than three years, and is now up 2.6% from a year ago.  In the meantime, inflation was a problem, largely due to higher oil prices, with GDP prices up at a 6.2% rate in Q2 and up 4.3% from a year ago.  As a result, nominal GDP rose at a 7.9% pace in Q2 and is up 5.6% annualized in the past two years.  We expect this to drop in the quarters ahead, but if it does not the Federal Reserve will likely get more pressure for a rate hike.  One reason we think nominal GDP will drop is that the M2 measure of the money supply has grown just 4.8% annualized over the past two years, which is less than nominal GDP and less than the 6.0% pre-COVID pace when inflation averaged below 2.0%.  In other news this morning, new claims for unemployment insurance rose 9,000 last week to a still very low 197,000.  Continuing claims declined 7,000 to 1.782 million.  These figures suggest moderate payroll growth in July.

Click here for a PDF version

Kevin Warsh’s second meeting as Fed Chair saw no change in rates and minimal edits to the Fed Statement, but included a press conference giving insight into what the Fed is focused on.  In an economy where Warsh described output as solid, capex and productivity as strong, and the employment market as steady, he views the answer to recent inflation problems as anything but straight forward, while making clear that the Fed is on the case.

In terms of the Fed Statement there was one key change, which is that three bank presidents previously approved by Jerome Powell dissented in favor of raising rates today, making it clear there is sentiment at the Fed to raise rates if the inflation picture doesn’t improve. At the press  conference, Warsh made clear that the Fed is committed to achieving the 2% inflation target.

Futures markets entered today’s meeting pricing in a near 100% chance of a rate hike coming by September.  Those odds are now closer to 50/50 for September with a hike now expected by October or December. Warsh reminded the markets that the Fed has tools beyond rates to work on inflation (for example, shrinking the Fed’s balance sheet), and appears to be winning the fight against the policy hawks.  The 10-year Treasury yield jumped to 4.69% today and appears to agree with this assessment. We believe he would prefer to hold off on rate hikes for the foreseeable future, but is battling the Powell faction – led by the former Fed Chair who remains on the board and as a member of the FOMC – and is working to gain the broader support of voting members to play the long game.    

It’s true that inflation measures remain above the Fed’s 2% target, and higher energy costs have shown in readings over recent months, but the M2 measure of money has been growing below the historical trend pace over recent years, and higher energy prices are likely to be offset by consumers eventually pulling back in other areas, which will see those other prices eventually decline.  We aren’t advocating for rate cuts any time soon, but we are fully on board with the Fed asking itself hard questions while they wait for more clarity on their dual mandate.  We look forward to what answers those hard questions bring. 

Brian S. Wesbury, Chief Economist

Robert Stein, Deputy Chief Economist

Click here for a PDF version

Implications:  New orders for durable goods rose a modest 0.3% in June versus the consensus expected 1.8%. The shortfall comes in the midst of a resurgence in capital investment for data centers, which has been a tailwind for economic growth in the first half of the year. Beneath the modest headline, activity continues at a solid pace. Transportation is a notoriously volatile category month to month, so we prefer to focus on orders excluding transportation for a better check on the broader economy. Orders excluding transportation continue to rise, up 0.6% in June and 11.0% in the past year, the largest annual gain in more than four years. The increase in these orders was led by computers & electronic products (+3.1%), primary metals (+1.1%), and electrical equipment (+0.9%). Notably, orders for computers & electronic products are up at a 23.8% annualized pace through the first half of 2026, second only to primary metals, which are up 28.0% over that same period. Orders for fabricated metal products and industrial machinery declined last month.  However, in the past year these categories are up 10.6% and 14.4%, respectively. Arguably the most important number in today’s release is core shipments – a key input for business investment in the calculation of GDP – which rose 1.9% in June and were up at an 11.1% annualized rate in Q2 versus the Q1 average. Business investment has shown strength recently as core shipments have consistently risen for the past year, driven by a more favorable tax environment and the data center buildout. The massive capital spending from the hyperscalers – projected to reach almost $700 billion this year – has been a tailwind for GDP for the past two quarters, and should continue to prop up growth if these companies can sustain the spending pace.

Click here for a PDF version

The more things change, the more they stay the same.

The US economy grew 2.0% in 2025 and it looks like it is growing another 2.0% this year.  Real GDP grew at a 2.1% annual rate in the first quarter and, as we set out below, it looks like it grew at a 2.0% rate in the second quarter.  

Which doesn’t mean everything is steady as she goes.  Data centers are where the action is and continue to grow rapidly, with the nominal value of construction of these structures up 23.0% from a year ago.  Likewise, shipments of computers and related products plus communications equipment are also up 23.0% from a year ago.

As we wrote in a recent Three on Thursday, capital spending by hyperscalers – like Amazon, Google, Meta, Microsoft, and Oracle – are projected to be almost $700 billion in 2026, which is $300 billion higher in 2026 than in 2025.  That alone would account for a full one percentage point of GDP growth.  In turn, that figure is in-line with findings from a recent paper from the St. Louis Fed on AI’s contribution to GDP growth.

Yes, it is possible that without all the investment in AI that other companies in other sectors would have easier access to capital and invest more, and that one percentage point figure doesn’t account for “crowding out” that other investment.  But it’s also the case that AI investment has led to more activity on sectors outside the technology sector, like power generation and water supply, and we are not counting that “crowding in,” either. 

The bottom-line is that in spite of the tailwind of AI and technological innovation, the overall economy is not booming.

Consumption: Auto sales soared at a 22.3% annual rate in Q2 while “real” (inflation-adjusted) retail sales excluding autos rose at a 6.8% rate.  However, real service spending – which makes up the lion’s share of consumer spending – appears up at only a 1.4% pace.  Combined, this brings our estimate of real consumer spending to a 2.2% rate, adding 1.5 points to the real GDP growth rate (2.2 times the consumption share of GDP, which is 68%, equals 1.5).

Business Investment: We estimate a 5.7% growth rate for business investment, with gains in equipment and intellectual property leading the way and commercial construction a continuing drag on growth (even including data centers, which are booming!).  A 5.7% growth rate would add 0.8 points to real GDP growth.  (5.7 times the 14% business investment share of GDP equals 0.8).

Home Building: Residential construction looks to have been unchanged in the second quarter, which is a victory of sorts considering it has contracted in every quarter since 2024.  We think this reflects a lack of workers to build homes while strict immigration enforcement makes more units available for rent.  Unchanged home construction means zero effect on the economy’s growth rate.  (0.0 times the 4% residential construction share of GDP equals 0.0).

Government: We are estimating that government purchases were still recovering in Q2 after the temporary shutdown of the federal government in the fourth quarter.  Modest growth at a 1.2% rate should add 0.2 points to the GDP growth rate (1.2 times the 17% government purchase share of GDP equals 0.2).

Trade: It looks like the trade deficit grew in the second quarter due to a surge in goods imports, although this forecast may change when a preliminary trade report arrives Tuesday morning.  For now, we’re projecting net exports will reduce the Q1 real GDP growth rate by 0.8 percentage points.

Inventories: We expect businesses added to inventories in the second quarter versus a decline in Q1, which should add what we estimate to be 0.3 percentage points to real GDP growth.

Add it all up, and we get a 2.0% annual real GDP growth rate for the first quarter, which would be lower if not for the boom in data centers.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

Click here for a PDF version

Implications: New homes sales may have surprised to the upside in June, but there wasn’t much to get excited about in today’s report. Sales rose a modest 1.6% in June and now sit at a 628,000 annual rate. That sales pace remains on the weaker end of pre-pandemic levels, which has been a ceiling of sorts for activity the past couple of years.  Unfortunately, the ongoing conflict with Iran and its impact on energy prices and inflation have introduced new challenges. First, financing costs have risen, with the average 30-yr fixed mortgage rate up roughly 50 basis points since the start of the conflict.  Second, despite a new Chairman at the Federal Reserve, further rate cuts are on hold for the time being. But while buyers are unlikely to get much help from interest rates, the good news is that prices have been trending lower for new builds in the past several years. Median sales prices are down 13.5% from the peak in October 2022.  Meanwhile, the Census Bureau reports that from Q3 2022 to Q1 2026 (the most recent data available) the median square footage for new single-family homes built rose 3.7%. So, buyers are seeing a drop in the price per square foot, not just smaller/lower cost options.  This is partially the result of developers offering incentives to buyers in order to move inventory. Supply has also put more downward pressure on median prices for new homes than existing homes.  The supply of completed single-family homes has been trending down recently but is still up 280% versus the bottom in 2022. This contrasts with the market for existing homes, which continues to struggle with convincing current homeowners to give up the low fixed-rate mortgages they locked-in during the pandemic to list their homes. While financing costs remain a headwind, less expensive options and an abundance of inventories may give home sales a modest boost in 2026. In other recent news, initial jobless claims fell unexpectedly last week by 22,000 to 187,000; continuing claims declined 2,000 to 1.796 million.  These figures signal continued job growth in July.  Finally, on the manufacturing front, the Kansas City Fed Manufacturing Index, a measure of factory sentiment in that region, declined to +9 in July from +11 in June.

Click here for a PDF version

An expected massive second quarter of earnings is underway for the S&P 500 Index and this week’s “Three on Thursday” takes a closer look at analysts’ expectations for earnings per share (EPS) for the S&P 500 Index. So where do Q2 earnings sit today, and where might they be headed next? For more insight, click the link below.

Click here for a PDF version

We’re back to reading tea leaves!  Hooray!  Next week the Federal Reserve will have its second meeting since Kevin Warsh officially took the helm.  And, at this point, the outcome is far from certain, which is unusual given that ever since Ben Bernanke instituted “forward guidance” the market usually knew what to expect.

Warsh does not think “forward guidance” is a good idea, therefore the market needs to read the tea leaves like in the old days.  Second, Powell won’t leave and appears to be quietly leading an opposition force.  And third, the inflation data are murky at best, with a few months of what appears to be a war-induced bump in inflation, and last month, the reverse. 

A rate “cut” would be a huge surprise, and even though the futures market is pricing in about a 10-20% chance of a “hike,” we think this is highly unlikely.

So why do markets think a hike is possible?  In part because Warsh has not gotten rid of the “dot plot” yet and at the last Fed meeting (in mid-June) out of nineteen members of the Board plus the bank presidents, three predicted one hike this year, five expect two hikes, and one policymaker is looking for three hikes.

In addition, Warsh said in Congressional testimony that, under him, the Fed has “no tolerance” for inflation above a 2% target.  He voted for no rate change in his first meeting in spite of many expecting him to push for rate cuts in response to pressure from President Trump.

However, President Trump appears to be bowing to the reality of both data and the Fed’s factions.  Trump said “I want him to be totally independent” – a sign that Warsh (and likely Bessent) have convinced the president that pushing for a rate cut may backfire and undermine Warsh’s leadership.  He needs time to consolidate the Board.

It’s been more than five years since inflation has been at or below 2.0%.  So, if the Fed doesn’t want to get there soon, then when does it want to get there?  A year from now? Two years from now?  Five?  Never?  Warsh claims he wants to get to 2.0% inflation, just like Powell did, but sooner or later (preferably sooner) the Fed must deliver 2.0% inflation or its credibility with the markets may diminish.

Another reason for a rate hike is that although the central estimate among Fed policymakers is that the federal funds rate will average about 3.00 – 3.25% range in the long run, which is lower than the current 3.625%, the Fed may need to bump that long-term estimate higher.  

Over long periods of time, the yield on the 10-year Treasury Note tends to hover around the growth rate of nominal GDP (real GDP growth plus inflation).  Nominal GDP has grown at a 5.4% annual rate in the past two years and at a 6.1% annual rate since the pre-COVID business-cycle peak at the end of 2019, which suggests a possible move upward in the ten-year yield in the years ahead.

In turn, in the past 50 years the federal funds rate has averaged about 1.15 percentage points below the 10-year yield.  This means a higher average 10-year yield would suggest a higher federal funds rate than 3.1% and maybe even higher than the current 3.625%.

However, there are also reasons why the Fed can be patient.  For one, when we compare regular Treasury securities to inflation-indexed securities, the five-year forward “breakeven” inflation rate remains about 2.4%.    

Yes, inflation remains stubbornly high, but we think official measures of inflation would already be lower were it not for the Iran War, and the ongoing Russia-Ukraine conflict, which have raised oil prices and cut global refinery capacity.

Also, while nominal GDP growth is a good target for interest rates, it can also mislead.  In the late 1990s, dot.com investment lifted GDP.  In the mid-2000s, home-building did the same thing.  And, today, data center building is making GDP growth appear stronger than it really is.  Without data centers, GDP growth is weaker, which would argue for lower rates. 

Moreover, in reading the tea leaves, Warsh told Congress recently that the Fed has other “tools” to fight inflation rather than just interest rates.  What he is referring to is the Fed’s balance sheet and Quantitative Tightening.  Trimming the Fed’s balance sheet would reduce liquidity in the banking system, which in turn would help hold down growth in the money supply.

The M2 measure of the money supply is up at only a modest 4.7% annual rate in the past twenty-four months.  And ultimately, unless money supply growth picks up, we think inflation will diminish.

Housing inflation is much more subdued than it was a few years ago and housing makes up a large chunk of inflation measures.  In addition, Warsh has shown interest in the Fed focusing more on “trimmed-mean” inflation rates, which tend to mute the effect of the most volatile prices.  Basically, they throw out outliers in inflation data on both the high and the low side and look at what prices in the middle are doing.

Put it all together and we think Warsh’s goal is to find a way to hold off the hawks on the Fed (what we will call the Powell faction) and avoid rate hikes altogether.  For now, he appears to be winning in this endeavor and it certainly looks like he has both the arguments and the support to play the long game and remain patient.  He has the Fed right where he wants it.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

Click here for a PDF version

Implications: Industrial production continued to grow at a slower pace in June, posting a modest 0.1% gain.  Looking at the details, the largest positive contributions came from mining and utilities, which both rose 0.4%. Gains in mining output were driven by both oil and gas extraction and drilling activity, which more than offset a decline in other mineral extraction. Notably, mining output is up at a rapid 12.1% annualized rate in the last three months, an encouraging sign that US energy companies may finally be ramping up output as supply disruptions continue in the Middle East. Meanwhile, utilities output (which is volatile and largely dependent on weather from month to month) has been on an upward trend since 2023, following nearly twenty years of stagnation, as power hungry data centers have boosted demand for US power generation. Unfortunately, the biggest source of weakness in June came from the manufacturing sector, which stalled for the first time this year despite a 0.6% increase in the volatile auto sector.  Manufacturing excluding autos (which we think of as a “core” version of industrial production) declined 0.1% in June, even though the typical bright spots in the “core” measure were present.  Production in high-tech equipment, which has been a reliable tailwind recently due to investment in AI as well as the reshoring of semiconductor production, increased 0.4% in June. High-tech manufacturing is up 11.1% in the past year (the fastest annual rate of any series) and up at an even faster 15.5% annualized rate in the past three months. Meanwhile, manufacturing of business equipment was up 5.5% in the past year, outpacing the 1.1% gain in overall industrial production and signaling a broader reindustrialization. In other news this morning, import prices increased 0.3% in June while export prices fell 0.6%.  In the past year, import prices are up 7.1%, while export prices have risen 10.2%.

Click here for a PDF version

Implications: Great headline, lousy details. Homebuilding surprised to the upside in June and beat even the most optimistic forecast of any Economics team polled by Bloomberg, rising to a 1.427 million annual rate.  However, the 19.0% monthly gain was entirely due to the multi-unit category where activity can move in big swings. That was the case in June as multi-unit construction rebounded 76% after plunging 40% in May. By contrast, single-family starts edged 0.2% lower and continue to spin their wheels, down 3.2% in the past twelve months.  Looking ahead doesn’t make the picture any rosier.  Permits for new builds lagged expectations and declined 3.0% in June to a 1.367 million annual rate, a three-month low.  This includes a 2.4% decline for single-family permits to their lowest level in almost a year.  Homebuilders have clearly faced a challenging environment in recent years.  Affordability remains the key issue, with 30-year mortgage rates reversing a recent decline and climbing back roughly 50 bps to 6.6% since the onset of the war in Iran, roughly double the levels that prevailed through much of 2021.  High home prices, restrictive local building regulations, tighter immigration enforcement making it difficult to find or replace workers, and tariffs are also contributing. Given these headwinds, it is no surprise to see the NAHB index (a measure of homebuilding sentiment) dropping to 34 in July from 36 in June, where a reading below 50 signals that a greater number of builders view conditions as poor versus good (now the 27th consecutive month that has been the case.)  In other housing news this morning, pending home sales, which are contracts on existing homes, declined 5.4% in June, following a 3.5% increase in May, suggesting a slight decline in existing home sales (counted at closing) in June.

Click here for a PDF version