GDP Growth Still Solid
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 10/21/2024
With third quarter GDP being reported next Wednesday – less than a week before election day – the US is still not in recession.
Yes, monetary policy has been tight, but the lags between tighter money and the economy are long and variable. In addition, massive budget deficits continue to provide incomes for a wide range of occupations. The official figures for Fiscal Year 2024 arrived Friday afternoon (isn’t it just like the government to announce bad news right before the weekend!) and the deficit was $1.832 trillion, or what we estimate to be 6.4% of GDP. That’s the second straight year with a deficit in excess of 6.0% of GDP, in spite of an unemployment rate averaging less than 4.0%. These deficits, which are unprecedented in size given peacetime and low unemployment, may have temporarily masked the effects of tighter money.
Meanwhile, innovators and entrepreneurs in high-tech industries and elsewhere have been overcoming government obstacles to push the economy forward. It’s hard to tell how much each factor (government spending or innovation) deserves credit for recent GDP growth, but roughly half of job creation in the past year has been in government and healthcare.
In the meantime, we estimate that Real GDP expanded at a 3.0% annual rate in the third quarter, mostly accounted for by growth in consumer spending. (This estimate is not yet set in stone; reports on Friday about durable goods and next Tuesday about international trade and inventories might lead to an adjustment.)
Consumption: In spite of tepid auto sales, overall consumer spending continues to rise, possibly because of continued government deficits. We estimate that real consumer spending on goods and services, combined, increased at a 3.5% rate, adding 2.4 points to the real GDP growth rate (3.5 times the consumption share of GDP, which is 68%, equals 2.4).
Business Investment: We estimate a 1.7% growth rate for business investment, with gains in intellectual property leading the way, while commercial construction declined slightly. A 1.7% growth rate would add 0.2 points to real GDP growth. (1.7 times the 14% business investment share of GDP equals 0.2).
Home Building: Residential construction dropped in the third quarter, hampered by the lingering pain from higher mortgage rates as well as local obstacles to construction. Home building looks like it contracted at a 5.0% rate, which would subtract 0.2 points from real GDP growth. (-5.0 times the 4% residential construction share of GDP equals -0.2).
Government: Only direct government purchases of goods and services (not transfer payments) count when calculating GDP. We estimate these purchases were up at a 1.8% rate in Q3, which would add 0.3 points to the GDP growth rate (1.8 times the 17% government purchase share of GDP equals 0.3).
Trade: Looks like the trade deficit shrank slightly in Q3, as exports and imports both grew but exports grew faster. We’re projecting net exports will add 0.2 points to real GDP growth.
Inventories: Inventory accumulation looks like it was slightly faster in Q3 than Q2, translating into what we estimate will be a 0.1 point addition to the growth rate of real GDP.
Add it all up, and we get a 3.0% annual real GDP growth rate for the third quarter. Not a recession yet, but that doesn’t mean that the US economy is out of the woods.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Have We Reached Peak Keynesianism?
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 10/14/2024
There are two types of economists in the world…demand-siders and supply-siders. Without digging too deeply, one huge difference shows up in government policy. Supply-siders want low tax rates, high savings rates (and investment), and minimal regulation. Why? Because wealth and higher living standards come from entrepreneurship and invention – i.e. Supply.
Demand-siders think the way to boost growth is to boost “Demand.” John Maynard Keynes is the father of modern demand-side thought, arguing that if the pace of economic growth is too slow the government can step in to “stimulate demand” by running or expanding a government deficit.
A tenet of Keynesianism is that growth is best achieved by taxing money from those with higher incomes because they have a “higher propensity to save,” and giving it to those with lower incomes because they have a “higher propensity to consume.”
No wonder politicians love Keynes. It’s an economic theory that sanctions giving taxpayer resources directly to people under the theory that this will boost overall economic growth. At least in the short run according to the Keynesians – less economic growth and fewer jobs are worse than deficits. (And the long run doesn’t matter, they say, because we’ll all be dead, anyhow.)
The policy response to both the Financial Crisis and COVID was Keynesianism on steroids. Clearly, politicians of both parties have rallied behind the Keynesian flag in the past 16 years. As Richard Nixon once said, “We are all Keynesians now.”
Nixon may have been right if we apply that statement to politicians. But Friedman, Hazlitt, Mises, Hayek, and others continually pointed out the damage from this short-term, demand-side thinking would be immense and the stagflation of the 1970s proved them right and the politicians wrong. Like then, we think we have reached “peak Keynesianism” again!
The fiscal well is now running dry. The federal budget deficit was 6.2% of GDP in Fiscal Year 2023 and came in about 6.4% of GDP in FY 2024, which ended two weeks ago. To put this in perspective, the US did not run a budget deficit of more than 6.0% of GDP for any year from 1947 until the Great Recession and Financial Panic of 2008-09. Not during the Korean War, not during the Vietnam War, not during the Cold War. But now we did it two years in a row without a war and with the unemployment rate averaging 3.8%.
These deficits were made possible, in a large way, by having the Federal Reserve monetize the debt. At the same time the Fed held interest rates artificially low, meaning the actual cost of these deficits was masked. But, like the 1970s, inflation appeared due to easy money and now interest rates are up. The interest on the national debt has soared from a modest 1.5% of GDP in FY 2021 to what is likely 3.0% of GDP in FY 2024.
This means that if we hit a recession anytime soon, policymakers will find it very hard to rely on a Keynesian response. Deficits and interest payments are already too high!
At the same time, a Keynesian-motivated redistribution scheme to try to boost spending also faces a major hurdle. The personal saving rate – the share of after-tax personal income that is not consumed – was 4.8% in August. That’s well below the 7.3% average in 2019, prior to COVID, and less than half the savings rate of 12% that the US had in 1965. What this means is that trying to boost consumer spending by taking from Penelope to pay Paul will probably not work, either.
Put it all together and it looks like the traditional tools Keynesians like to use when economic troubles hit will not be available if the US runs into economic trouble. We see it everywhere. Evidently, the Secret Service, FEMA, and border security all need more money.
The system has reached Peak Keynesianism. Like the late 1970s and early 1980s, it is time to change course. The good news is that because of democracy, this can happen any time.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
The Politics of Limits
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 10/07/2024
The federal debt is already $35 trillion and currently rising by roughly $2 trillion every year – with no end in sight. As a result, some investors are worried that the US could become a 21st Century version of Argentina: completely bankrupt and unable to pay the bills.
We don’t think that’s going to happen. It’s not that the national debt doesn’t matter, it does matter. Instead, it’s because the recent surge in the interest on the national debt is going to have big effects on government policy.
The best way to measure the manageability of the national debt is not the top-line debt number, $35 trillion in the case of the US. Instead, it’s the net interest cost of that debt relative to GDP. Think about it like a national mortgage payment relative to national income.
Back in the 1980s and 1990s the US was regularly paying Treasury bondholders roughly 3.0% of GDP. From Fiscal Year 1982 through 1998, the interest cost on the debt relative to GDP hovered between 2.5% and 3.2%. At this level, even politicians felt the pain. Both parties enacted policies that led to budget surpluses and interest costs relative to GDP plummeted. Between FY 2002 and 2022 the interest burden averaged roughly 1.5% of GDP and stayed between 1.2% and 1.9% of GDP.
We call this period the “Age of Candy.” What happened during the Age of Candy? We cut taxes in 2001, 2003, and 2017. In 2004 the US added a prescription drug benefit to Medicare. In 2010, with Obamacare, we enacted the first major expansion of entitlements since the 1960s – not by coincidence, another period when the interest burden on the debt was low.
Why did all this happen? We are sure others can come up with plenty of ideas, too. But we think a large factor is that when the interest burden of the debt was low (which meant they didn’t have to pay bondholders as much) politicians realized they had a lot of extra money sitting around to buy our votes. And that’s exactly what they did.
But the Age of Candy is finally coming to an end. In FY 2023 the interest burden hit 2.4% of GDP, the highest since 1999. And in FY 2024, which ended exactly one week ago, the interest burden is on track to hit 3.0% of GDP, the highest since 1996.
In the twelve months ending in March 2021, net interest totaled $315 billion. In the past twelve months it’s totaled $872 billion. That’s an increase of 177% in less than four years.
A big part of the problem is that the Federal Reserve was holding interest rates artificially low. The Treasury Department could have issued long-dated debt to lock in lower interest rates for longer. But like homebuyers between 2004-2007, they borrowed at short-term rates, which were even lower and that meant more room in the budget to spend, spend, spend.
High inflation finally forced the Fed to raise interest rates back to normal levels. Unfortunately, this inflation only represents part of the problem. The bigger long-term problem is that by holding rates artificially low, the Fed fooled politicians into believing the cost of deficits was minimal. Hopefully, America will look back on this period and realize that Fed policy and all that spending was a mistake.
Ultimately, however, we think the spike in the amount that the government has to pay bondholders will lead to more focus on controlling the budget deficit in the years ahead. Unlike the homebuyers who defaulted on their mortgages in the Great Financial Crisis, government can buy itself time. During the period from 1982-1998, the Politics of Limits took place.
Think about what lawmakers did during that timeframe. In 1982, there was a bipartisan deal to raise the payroll tax. In the mid-1980s we had a bipartisan trio of Senators (Gramm-Rudman-Hollings) push legislation to try to control the growth of spending. In 1990 George Bush the Elder cut a deal with the Democrats to violate his “no new taxes” campaign pledge, raise taxes, and set spending caps on miliary and social spending. Then Bill Clinton and Congress raised taxes even more, kept the Bush-era spending caps in place, and reformed Medicare and welfare to reduce spending.
That was the Politics of Limits. Don’t be surprised if by 2026 the bond market vigilantes have their machetes fully sharpened and once again bring politicians to heel. The Age of Candy is coming to an end. Will politicians react the same way in the years ahead? We hope so, because if they don’t inflation will not go away and investor fears may be warranted.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Profits and Stocks
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 10/01/2024
Like it does once every year, last week the Commerce Department went back and revised its GDP figures for the past several years. And while the top line revisions to Real GDP were pretty small, there was a larger revision to corporate profits.
Real GDP was revised up 1.3% for the second quarter of 2024, which means the annualized growth rate since the start of 2020 was about 0.3 percentage points faster than previously estimated: 2.3% per year rather than 2.0%.
And the statisticians also said profits were underestimated. The government now thinks its comprehensive national measure of pre-tax corporate profits is 11.5% higher than previously thought, mostly due to profits at domestic non-financial companies (such as manufacturers, retailers, transportation & warehousing, etc.). Meanwhile, after-tax profits were revised up 13.3%.
As our readers know, we judge the value of the overall stock market by using a Capitalized Profits Model. Using these revised economy-wide profits from the GDP accounts and a 10-year yield of 3.75% (Friday’s close) suggests the S&P 500 would be fairly valued at about 4,725, 18% below Friday’s S&P 500 close.
Our readers know that this measure is a view from 30,000 feet. The Capitalized Profits Model is not a trading model and there are many other tools to judge the value of stocks. In addition, in an election year, another factor is in play as well and that is the tax rate on corporate profits.
In 2018 the top tax rate on corporate profits was cut from 35% to 21%. This 21% tax rate is the lowest tax rate on corporate profits since the Great Depression.
We have always used pre-tax profits to judge stock values because the corporate tax rate moves up and down with the political cycle and pre-tax profits are a true reflection of economic activity, not just tax rate changes.
Clearly, the stock market has continued to rise in spite of the fact that our 30,000-foot view suggests it is overvalued. This could be a repeat of what happened in the late 1990s, when stocks rose in spite of the fact that they were overvalued, or it could be explained by an expectation that tax rates will stay low, and possibly be cut again.
Using newly revised after-tax profits in our model, instead of pre-tax profits, suggests that stocks are fairly valued today. And if President Trump were to win the election, and cut the corporate tax rate further as he has suggested (to 15%, from 21%) then there’s a case for stocks being mildly undervalued. (In theory, cutting the tax rate to 15%, which means companies would get to keep 85 cents on the dollar rather than 79 cents, translates into an 8% increase in after-tax profits).
However, there is also a risk of corporate tax increases, both in the near future as well as beyond. Vice President Harris’s campaign has mentioned lifting the rate to 28%, which would translate into a 9% reduction in after-tax profits.
It is hard to look at the federal budget situation and think the US government won’t be raising tax rates in the future. We’d prefer spending cuts, but we don’t live in a world where policymakers do what we want. In a worst-case scenario, tax rates could go up on both corporate profits as well as investors’ capital gains.
Net, net, what does this all mean? At the very best, upward revisions to profits mean stocks aren’t as overvalued as our models showed before. Nonetheless, with the M2 measure of the money supply down from its 2022 peak, and the risk of recession higher than it has been in a long time, we still believe stocks are overvalued.
The Federal Reserve is reducing interest rates, but even with a 10-year yield of 3% the stock market is not cheap. From 2008 to 2022, the market was significantly undervalued, and we were bullish for almost that entire time. Today, this is just not the case. There are sectors of the market that remain less expensive than the market as a whole, but caution is still warranted.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material presents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
The Budget Blowout
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 09/23/2024
With only one week left in the fiscal year, it looks like the budget deficit for the federal government for Fiscal Year 2024 is going to come in at about $1.9 trillion, which is 6.7% of GDP.
To put this in historical perspective, we know of no other year in US history where in the absence of a major full mobilization war (like World War I or II) or a major recession and its immediate aftermath when the budget deficit was so large. Some may point out that the budget gap was this large in FY 2012, a few years after the Financial Panic and Great Recession of 2008-09. However, the unemployment rate averaged 8.3% that year, more than double the average jobless rate of 4.0% this year. In other words, the economy in 2012 was still far from a full GDP and job-market recovery.
You may not remember, but Democrats hammered Ronald Reagan for deficits in the 1980s. Well, looking back the largest deficit we ever had under Reagan was in 1982, when the unemployment rate was 10% and we were fully funding the Pentagon at the height of the Cold War.
In other words, there is simply no excuse for running a deficit this large given the lack of a major war and the absence of a recession.
And yet here we are. What’s amazing is how much the budget situation has changed in only the past five years. When looking at the budget it’s important to compare apples-to-apples, so we like to use the budget at the same point in the business cycle. In 2019 the economy was at a pre-COVID peak and 2024 is, so far, a peak business-cycle year as well. (It remains to be seen if 2025 is an even higher peak, in which case we will be happy to make a 2019 versus 2025 comparison a year from now).
Five years ago, in FY 2019, the deficit was 4.6% of GDP, so with this year at 6.7% it is 2.1 percentage points higher. Is it higher because of less revenue? Not at all. In the past five years revenue as a share of GDP has risen to 17.2% from 16.3%. They were $3.5 trillion in 2019, this year they are $4.9 trillion, $1.4 trillion higher.
Instead, the problem with the growing deficit is on the spending side. And while many just chalk it up to Social Security and Medicare because of our aging population, this just isn’t true. There are three major factors: (1) net interest on the federal debt, (2) “other” mandatory spending, and (3) major health care programs, such as Medicare (for senior citizens) and Medicaid (for those with lower incomes).
The growth in the net interest on the federal debt has been astounding and we plan to write more about the major political and policy implications of that change in the months ahead. Back in 2019, net interest was 1.8% of GDP; this year it will clock in at 3.1% of GDP, the highest share since 1995.
Meanwhile, “other” spending is up because the Biden Administration has been busy finding ways to forgive as many student loans as it can legally get away with (as well as ways that may end up being illegal, like with policy changes announced in 2022 and later overturned by the Supreme Court). When loans are forgiven, the Department of Education calculates present value of less future repayments, and factors that into the current budget year. As a result, “other” spending, which was 2.7% of GDP in 2019 is 3.8% this year.
Then there are the health care programs, which cost 5.3% of GDP five years ago, but 5.8% this year, with Medicaid growing much faster than Medicare. With population aging and barring major reforms to these programs, this share should only grow in the decade ahead.
The bottom line is that the US faces big structural budget challenges in the years ahead, particularly on the spending side. With low interest rates in the past fifteen years, we had the chance to avert our eyes from the problem, but we are soon to run out of time. No matter who we elect in November, we expect getting our fiscal house in order to eventually become a major policy theme of the next Administration as well as those beyond.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
It’s Money, Not Spending, that Causes Inflation
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 09/16/2024
You don’t have to read or listen for long these days before you hear a politician, pundit, or politically-inclined person say: “Government spending causes inflation.”
Don’t get us wrong…anyone who wants to cut the size and scope of government is a friend of ours. Government is WAY too big. It slowed the growth rate of the economy, hurt living standards, and made people fight over fixed slices of the pie rather than working to grow the pie. But, government spending, itself, doesn’t cause inflation.
Just think about it. If government taxes (or borrows) $1,000 from Peter and gives that $1,000 to Pauline…Peter doesn’t have it, but Pauline does. Is there any more money in the economy? Absolutely not.
The only thing that can increase inflation – in fact, the definition of inflation – is excess money creation. Inflation is a decline in the purchasing power of a currency caused by central banks that inject more money into an economy than an economy really needs. Inflation isn’t an increase in the prices of goods and services, it’s a decline in the value of money. And government spending, all by itself, does not increase the money supply.
And if you don’t believe us, how about Milton Friedman? He wrote “Fiscal policy is extremely important in determining what fraction of total national income is spent by government and who bears the burden of that expenditure. By itself, it is not important for inflation.”
Some people wrongly assume that government borrowing creates money. But think about it. Who does the government borrow from? China, Japan, retirees, and banks all buy Treasury bonds. They buy them with dollars that they earned exporting to the US, working for incomes, or taking in deposits.
If any entity buys the debt of the US they no longer have the cash, the government does. Like Peter and Pauline, it is just a transfer of cash from one account to another. It doesn’t increase spending. If China buys debt, then they can’t buy imports with those same dollars. If banks buy debt, then they can’t make loans with that same money.
What is true is that if the Fed (or any central bank) creates new money (say with QE) and buys government debt, this injects new money into the economy. That IS inflationary. But it’s the money creation that caused the inflation, not the spending itself.
We think government spending needs to be cut. In fact, it may be the most important policy proposal on the table today. But we should cut spending for the right reasons. Making mush of economics doesn’t help anyone in the long run.
In that vein, many people correctly point out that the more the government borrows and taxes, the less the private sector has. This slows the growth of the economic pie and holds back the production of goods and services. Fewer goods and services, with the same monetary policy, means higher prices than we would have if government were smaller.
But this is not inflation, it is a (negative) supply-side boost in prices. The Fed could pull money growth back in such a situation and keep prices from rising as much, but the Fed actually does the opposite. The slower the economy grows, the more likely the Fed is to print excess money to boost it.
Again, this excess money is what causes the inflation, not the government spending. Even though a bigger government holds back output, it is not the ultimate cause of inflation.
The US was able to fix the inflation of the 1970s by slowing down the growth rate of the money supply. And, contrary to popular belief, the US does not need easy money and low interest rates to grow. In fact, the high-tech sector has thrived with declining prices.
Let’s cut spending for the right reasons. We get it: if saying spending creates inflation and that bumper sticker argument gets voters on board it would be easy. But the real reason to cut the size of government is to create more of a free market, reduce corruption, and allow workers to keep more of what they earn.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Slower Faster
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 09/09/2024
Friday’s employment report suggests the US economy may be slowing down faster than most investors think.
Nonfarm payrolls increased 142,000 in August, but revisions to June and July brought the net gain down to a modest 56,000. And the details were worse. We like to follow payrolls excluding three sectors: government, education & health services, and leisure & hospitality, all of which are heavily influenced by government spending and regulation (that includes COVID lockdowns and reopenings for leisure & hospitality). That “core” measure of payrolls rose only 25,000 in August and is up only 31,000 total in the past three months.
In particular, government plus education & health care jobs have made up 37% of all the net payroll increases since the pre-COVID peak in February 2020, an unusually large share.
For August itself, things looked better if you focus on civilian employment, an alternative measure of jobs that includes small-business start-ups, which rose 168,000 for the month. However, it’s hard to make a strong case for the US economy if you stick with that civilian employment measure. The August gain was the largest in five months but civilian employment is down compared to a year ago, with a loss of 66,000 jobs. Even worse, full-time employment is down one million from a year ago while part-time employment is up 1.1 million over the same timeframe.
Another recent report from the Labor Department revised down the payroll increase in the year ending in March 2024 by 818,000. That makes sense given that payrolls had been previously estimated to have grown 2.9 million during this period while civilian employment was estimated to have grown 642,000. But even after reducing payroll growth by 818,000 that still leaves a large gap. One way to close that remaining gap is an upward revision to population numbers due to high immigration, which would lift civilian employment, as well. But another way would be an even larger downward revision to payrolls.
This week the Labor Department will report on inflation and we – and the consensus – expect a moderate 0.2% increase in consumer prices for the month of August. In turn, that would mean that CPI prices were up around 2.5% from a year ago, which should translate into PCE inflation (the Federal Reserve’s preferred measure) of 2.3%. That’s a big drop from the 3.3% gain in PCE prices in the year ending in August 2023 and suggests that by the early part of next year inflation may temporarily hit or go under the Fed’s 2.0% target.
Why is this happening? Why is the economy slowing and inflation decelerating? Because monetary policy has been tight. After surging in 2020-21, the M2 measure of the money supply peaked in early 2022. Although it’s been rising gradually since October, it’s still down 3.1% from the peak in April 2022.
The Fed obviously realizes this, hence all the talk about cutting short-term interest rates. For now, our base case is that the Fed will cut rates by a quarter percentage point at each of the three remaining meetings this year (starting next week) and continue that pattern well into 2025.
The problem is that the Fed still thinks its focus should be on rates, not the money supply. If growth in M2 picks back up quickly, we risk a return to higher inflation, like we did multiple times in the 1970s. If growth in M2 remains lackluster in spite of rate cuts, the landing could get harder than anyone thinks.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Celebrating Workers
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 09/03/2024
Labor Day was celebrated around the country yesterday and, as usual, when doing so there were speeches extolling the virtues of hard work and workers’ contributions to America, as well as assertions about why the living standards of American workers have risen so much in the past few generations.
In turn, that often meant extolling the supposed virtue of government action and regulation, like government-enforced rights to collective bargaining, laws that set minimum wages and maximum hours, as well as rules about working conditions. In this worldview the key to helping workers is for them to vote for politicians who will, through government action, improve their lives.
By contrast, we think that when it comes to lifting workers’ material standard of living, that government action should take a backseat (maybe even barely a seat at all) compared to free-market capitalism.
Worker compensation depends on the ability of employers at businesses of every size, ultimately led by an entrepreneur, to convert worker time and effort into more goods and services. In turn, that depends on new technology, which makes workers more efficient. Education matters, too, although we know of many successful entrepreneurs who dropped out of college. Well-managed companies make workers more productive; meanwhile some stalwart companies of decades past are focusing on things other than productivity and these companies and their workers will suffer losses.
In other words, rather than celebrating labor unions and government, Labor Day should be used to celebrate free-market capitalism.
It also should mean being on the lookout for obstacles to the free market, including growth in the size of government as measured by both government spending and regulation.
That said, there is something almost quintessentially American about Labor Day, as opposed to the celebrations of May Day in other places around the world. While claiming to celebrate workers, May Day is really about celebrating some intellectuals’ conception of workers as a “class,” or a block of voters or protestors who enable these intellectuals to seize authoritarian power in the name of those workers. This is not great for workers.
We say “almost” American because a Labor Day holiday rather than May Day is also celebrated in Canada, Australia, New Zealand, and Japan, some of the most prosperous places in the world. May Day is celebrated in some western European countries where, while living standards have not stagnated as much as in more socialist countries, growth and prosperity are starting to fall behind.
The bottom line is that prosperity for workers and entrepreneurs requires free exchange between these groups. They need each other and do better when they can interact outside the supervision of rent-seeking intellectuals and politicians who think they know better.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Rate Cuts on the Way
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 08/26/2024
We all knew it was coming…and in Jackson Hole, Federal Reserve Chairman Jerome Powell said it will come next month. He said, “the time has come,” and the futures markets have priced in either a 25 or 50 basis point rate cut at the meeting on September 18.
While the world seems to think the setting of the federal funds rate is the most important decision in monetary policy, we don’t think that’s true. With the advent of the abundant reserve policy in 2008, the Fed separated the link between the money supply and interest rates.
In reality there are multiple things we watch to determine the stance of monetary policy. Interest rates are one, but the rate of growth in M2 is more important…and that growth rate can now be influenced by what the Treasury Department does with the $730 billion it holds at the Fed in something called the Treasury General Account (TGA).
We think the real reason inflation has slowed is because the Fed actually allowed M2 to decline after the massive increase during COVID. Yes, short term interest rates were very low. But it wasn’t those low rates that caused the inflation, otherwise short-term rates that were just as low in the aftermath of the 2008-09 Financial Crisis would have caused a similar surge in inflation.
Similarly, it wasn’t the hikes in short-term interest rates that brought inflation back down. It was the slowdown in M2, in part caused by the growth of the TGA, which the government has used to take roughly $700 billion out of circulation.
This new system of abundant reserves and a large TGA has pushed the US very close to Modern Monetary Theory, where the Treasury can take money out of circulation by borrowing or taxing from the public and then hiding it in the TGA. And the Treasury could always drain the TGA and push $700 billion back into circulation by spending.
We don’t know exactly what the Treasury or Fed will do with Quantitative Easing/Tightening and the TGA, but many seem to believe cutting rates will allow the US to avoid a hard landing. With M2 barely growing, this may not work.
Since 2008, the Fed has held short-term interest rates below inflation 80% of the time, and for nine years, interest rates were basically held at zero. With inflation running 2.5% to 3.0%, the Fed could take the federal funds rate down a full percentage point to roughly 4.5% and rates would be “normal,” unless and until inflation falls further.
Meanwhile, the housing market is probably not poised to surge as short-term interest rates start to decline. Mortgage rates are not going to fall back to 3%. In addition, when the Fed starts cutting rates and people think they will cut them more, they could hold back on purchases waiting for the even lower rates. So sometimes, rate cuts can lead to slower growth in the near term. Also, we have a presidential candidate suggesting a large tax credit for some buyers, which could also postpone purchases into next year.
The Fed has been running an experiment in new monetary policy…in other words, don’t start believing that this change in direction from higher for longer, to lower is the way to stick the landing. We still haven’t felt the full pain from policies undertaken during COVID lockdowns…it takes a lot of imagination to believe all this can happen with no real negative impact.
We are worried that we have come very close to state-run capitalism. In the past year, 82% of all net new jobs have been in government, healthcare and education. Growing budget deficits have been holding up the economy even though the money supply has gone negative. Now, with deficits no longer rising as rapidly, the Fed will try to become the engine behind growth.
But pushing growth with government spending and Fed policy is a dangerous mix that could ignite the embers of inflation before the fire is completely put out. Gold rose to a record high last week, Bitcoin rallied too. The markets are not convinced that inflation has been tamed.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Price Controls Redux?
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 08/19/2024
Unfortunately, when it comes to the government, what’s old is sometimes new again.
Back in the late 1960s and 1970s the Federal Reserve printed too much money relative to Real GDP, resulting in repeated bouts of high inflation. President Nixon, having been burned by a mild recession in 1960 the first time he pursued the presidency, wanted to make sure there was no hint of recession in 1972, the year he’d be seeking re-election.
As a result, in 1971, when Nixon closed the “gold window” at the Fed – to give the Fed the chance to print money more freely – he also imposed wage and price controls to try to temporarily hide the inflation that would inevitably result. After the election the controls went away and inflation surged, averaging more than 9% per year from 1973 through 1975. No wonder Nixon got so unpopular after the election!
But price controls have a long and sordid history all over the world, including in ancient Egypt, Babylon, as well as ancient Rome and even modern-day Zimbabwe and Venezuela. During the French Revolution, in 1793, the rapid inflation caused by the paper money issued under the revolution led to price controls enforced by the death penalty, then implemented by the guillotine. But even lopping off heads didn’t fix the problem and shortages were one of the damaging results.
Why do governments periodically do this? Because inflation is political kryptonite. Prior to COVID the US had inflation under control for almost forty years. Now, with inflation having remained stubbornly high the past few years – even though it’s decelerated the last two years – some politicians feel compelled to act, especially because while the rate of inflation is down, the price increases of recent years are still in place.
Politicians say it couldn’t possibly be their fault prices went up too fast, it must be someone else’s, like those wicked “price gougers’ in the private sector, lining their pockets with workers’ hard-earned dollars. But if price gouging is the reason for recent inflation, why weren’t these gougers doing it the past forty years? What changed?
And why has the inflation been such a global phenomenon? Inflation surged around the world, not only in the US. Is every single company in the world price gouging, and if so, doesn’t that present a once in a lifetime opportunity for someone to take market share by reducing prices?
Meanwhile, the cost of government has soared but those who accuse the private sector of price gouging are ignoring that. Since 2012, Chicago school spending per student is up 97% even as test scores have gone down.
But we shouldn’t just pick on Chicago schools. A recent study that used AI looked at SAT scores since 2008. Including the effect of the test getting easier, average math scores are down more than 100 points in the past fifteen years with most of the drop since 2019, right before COVID. Those who want to impose price controls on the private sector want to punish shrinkflationists. But schools have been charging more and shrinking the education they’re giving our kids. Where is the plan to fix that?
Ultimately, the best way to fight inflation is to have the Fed focus on price stability while the government minimizes taxes and regulation to encourage competition and risk-taking. Competition, not new regulations, is the way to keep prices down. School vouchers would certainly accomplish this for education.
The key assumption behind price controls is the rationalist delusion that some group of policymakers can figure out what a “fair” price is for each and every good and service across the vast US economy. It’s the pretense of the kind of central planners who ran the Soviet Union’s economy for decades.
The good news is that we think price controls are a very long shot to take effect. Even already, a candidate suggesting price controls is backpedaling, probably realizing that many political allies think it’s a very bad idea. Meanwhile, it’s unlikely that, outside wartime, such a plan could be imposed without new legislation and that legislation would probably not have the votes to pass.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
The Week Ahead
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 08/12/2024
Pretty much every month there’s one week that has the most important economic reports. For the month of August that’s this week. The reports this week include consumer price inflation, producer prices, retail sales, industrial production, housing starts, and unemployment claims.
As it stands, it looks like the broader economy is decelerating as the tighter monetary policy of the past two years finally gains traction. The deceleration has taken longer than it normally does, probably due to the unusual nature of COVID lockdowns and reopening, the massive amount of monetary stimulus that preceded the tightening, plus the unusual expansion of the federal budget deficit last year, in spite of low unemployment and a Supreme Court decision on student loans that artificially reduced the official deficit last year.
In the past two weeks economic reports have included a decline in construction, slower job growth, and mixed ISM indexes, with manufacturing signaling contraction while the service sector remains slightly positive.
What’s likely for this week? It looks like both consumer and producer prices rose 0.2% in July, which would be welcome news compared to the higher average inflation rates of the past few years. If tighter money is gaining traction, these inflation rates should slow even further later this year. It doesn’t mean this trend will be permanent, though. Eventually the Federal Reserve will loosen once again, probably too much, and send inflation higher.
Meanwhile, retail sales and industrial production should bring mixed news. Due to a bounce back in auto sales in July, after the technology-related snafus at auto-dealers in June, total retail sales should be up for the month. However, even if they grow the 0.5% we expect, that would leave them up only 2.5% from a year ago, barely treading water versus inflation.
Worse, we anticipate a decline in industrial production for July, led by the manufacturing sector. Production should still be up slightly versus a year ago, but not by much.
Does this mean the US is already in recession? Not yet. But dark clouds are gathering. Monetary policy is tight right now and has been for some time. Meanwhile, capital standards for banks are likely tightening up even as cuts in short-term rates are nearing. Investors should be wary about slower economic growth than the financial markets now assume.
In the meantime, taking all these data in, it looks more like stagflation than at any time since the 1970s. In spite of AI, space travel, and 3D printing, the economy is growing slowly with inflation still above the 2% level most people have wrongly considered “price stability.” COVID lockdowns and then reopening have seriously impaired seasonal adjustments. Massive federal deficits have allowed spending to continue, but created a bill that is coming due.
The US has backed itself into an economic corner where many are demanding more government interference. We wish we knew exactly how this will end, but experimental policies of the Fed and Treasury are making it very hard to predict.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
The Lags are Over for Tighter Money
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 08/05/2024
As Milton Friedman taught us many decades ago, monetary policy works with long and variable lags. Recent economic reports suggest that the long and variable lags on the tightening of monetary policy in 2022-23 are starting to come to an end.
Both inflation and economic growth are decelerating. Consumer prices declined 0.1% in June, the largest drop for any month since the early days of COVID. Much of this was due to a decline in energy prices, but even “core” consumer prices were soft, up only 0.1% for the month, the smallest increase for any month in more than three years. The CPI was still up 3.0% in June versus the year prior, but this year-ago comparison looks like it decelerated in July and will probably do so again in August, given that oil prices are down.
Meanwhile, we are seeing more and more softness in the economy. The housing sector remains mired in slow construction and slow sales. The dollar value of new private housing construction is down in each of the past three months. Recent existing home sales are near the lowest level since the housing bust in 2010; new home sales are lower than they were prior to COVID.
The national ISM Manufacturing index came in at 46.8 for July, below the forecast from every economics group that submits a forecast to Bloomberg and, more important, below 50, which signals contraction. The production component of the index declined to 45.9, the lowest since the COVID Lockdown.
And then the July employment report showed a marked deceleration in job creation, with payroll gains (net of downward revisions for prior months) a tepid 85,000. We like to follow payrolls excluding government (because it's not the private sector), education & health services (dominated by government) and leisure & hospitality (which is still recovering from COVID Lockdowns). That “core” measure of payrolls rose just 17,000 in July, the smallest gain so far this year. At the same time, the unemployment rate rose to 4.3%, 0.4 percentage points higher than it was three months ago, an increase that in the past has often (but not always) been associated with a recession.
It is true that the M2 measure of money bottomed in October and has since been trending upward, but the gain since then has only been 2.4% annualized, much slower than the 6.1% annualized average during the twenty years leading up to COVID, a time when the CPI gained a moderate 2.1% per year.
Put it all together – decelerating inflation and decelerating growth, along with an abnormally slow rebound in M2 – and we have a strong case that the Federal Reserve has implemented tight money. In turn, given the lags between shifts in policy and its economic effects, the Fed now has room to shift to a monetary policy that is less tight.
To most analysts and investors, that means cutting the short-term target rate. As of late Sunday, the futures market in federal funds showed almost 125 basis points in rate cuts later this year. But lower rates, by themselves, are not easier monetary policy.
Instead, the Fed needs to start focusing on the money supply, particularly on M2. If the Fed cuts short-term rates but growth in the money supply remains weak because of tighter capital requirements on banks or because businesses and consumers expect even lower rates further ahead (which might lead them to temporary postpone economic activity) then it isn’t really making monetary policy less tight.
There is a widespread myth that 1980s Fed Chairman Paul Volcker beat inflation by sharply raising short-term interest rates. In truth, he did no such thing. What Volcker did was focus on the money supply and getting its growth under control. That meant using the Fed’s open-market operations to soak up excess liquidity. And it was those operations which resulted in higher short-term rates and lower inflation. The causation is important: less money meant higher rates, but Volcker’s focus was on the money. If he could have withdrawn the excess liquidity without higher rates, he would have been happy to do so.
The problem today is that the current Fed has abandoned a focus on the money supply and has swapped a system of scarce reserves for one in which reserves are excessively abundant, which means short-term interest rates are directly controlled by the government, rather than the market.
Investors have a great deal riding on whether the Fed gets it right. Focusing on the money supply will help show how successful the Fed will be.
And, finally, there is a real potential here for the Fed to overreact. The world has gotten used to extremely low interest rates and very easy money. The stock market was overvalued and unemployment was artificially low. If the Fed thinks that was normal it will try to add more money than needed and risks creating stagflation. Just like it did in the 1970s.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Want Affordable Housing? Build Homes, Cut Government
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 07/29/2024
Listen to enough politicians and it won’t take long to hear about the lack of “affordable” healthcare, drugs, daycare, and housing. This was going on long before inflation returned after COVID. Everyone wants affordable things.
But the concept of affordability is made up of two components – the price of something and the income of the person who wants to possess it.
There are complicating factors in every market, so let’s focus on one – housing. Almost everyone thinks home prices and rents are just too damn high.
Many blame this on greedy landlords and investment firms buying up apartments and homes. President Biden (prior to his withdrawal from the presidential race) said he wants to impose a form of national rent control on “corporate” landlords.
There should be no doubt that a typical home today costs much more relative to income than it used to. The median price of an existing single-family home that sold in 2022 was about $390,000, which was 5.2 times higher than median household income of $74,580 that year (the most recent year for which median income is available).
By contrast, back in 1968, the median price of an existing single-family home was only 2.6 times median household income. As recently as 2011, the bottom of the housing bust, the ratio was only 3.3 and even at the peak of the housing boom in 2005, the ratio was 4.7. No wonder so many people are finding housing hard to afford.
This is not due to greedy landlords and homebuilders. Government entities of all kinds restrict building and add massive costs through regulation, which all limit housing supply. And don’t forget the inflation caused by excess money printing. Many workers in the US have not seen their wages keep up.
On top of this the US has allowed massive immigration, which increases the demand for housing, while homebuilders have not built enough new homes for basically the last 15 years – since the housing bust of 2007-2009.
But the least talked about issue with affordable housing is the income side. Today, federal, state and local government expenditures, plus the cost of complying with government regulations take at least 50% out of the entire Gross Domestic Product of the United States.
In other words, working Americans, on average, are left with only 50% of what they earned. If government used that money to do things that were more productive than the private sector, we would all be better off. But government programs are less efficient. Elon Musk’s SpaceX is massively more efficient than NASA ever was.
The more the government spends based on political priorities the less taxpayers can spend. And taxing Peter to give money to Paul makes it harder for Peter to buy a house, while Paul probably can’t afford one either. Redistribution limits opportunity. The more the government grows, the less affordable housing becomes. And, yet, no one talks about it.
Ultimately, if populists want to address the problem of housing affordability, they need to give power to the people by letting them keep their earnings, while government stops giving money to people, while grabbing power for itself.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Moderate Growth in Q2
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 07/22/2024
There are signs US economic growth is slowing down. In particular, jobless claims, perhaps the best high-frequency economic indicator, have averaged 235,000 per week in the last four weeks versus 211,000 in the first quarter. Meanwhile, continuing jobless claims are creeping up while overall retail sales are up a meager 0.2% in the past six months, slower than the pace of inflation.
The US is not in a recession at this point but higher claims and soft sales, along with a renewed deceleration in inflation (consumer prices ticked down 0.1% in June), suggest that the drop in the M2 measure of the money supply from early 2022 through late 2023 is finally gaining traction.
We may also be witnessing the end of the temporary and artificial impact of last year’s surge in the budget deficit. In the absence of the Supreme Court’s decision to overturn much of President’s Biden’s plan to forgive student loans, the budget deficit would have been 7.5% of GDP last year. That’s well larger than any year on record when the US was not engaged in a World War and the unemployment rate was below 4.0%.
We estimate that Real GDP expanded at a 2.1% annual rate in the second quarter, mostly accounted for by an increase in consumer spending. (This estimate is not yet set in stone; reports Wednesday about international trade and inventories might lead to an adjustment.)
Consumption: “Real” (inflation-adjusted) retail sales outside the auto sector grew at only a 0.3% annual rate in Q2 but auto sales rebounded at a 9.8% rate. Meanwhile, it looks like real services, which makes up most of consumer spending, grew at a 2.1% pace. Putting it all together, we estimate that real consumer spending on goods and services, combined, increased at a 2.1% rate, adding 1.4 points to the real GDP growth rate (2.1 times the consumption share of GDP, which is 68%, equals 1.4).
Business Investment: We estimate a 1.7% growth rate for business investment, with gains in intellectual property leading the way, while commercial construction declined slightly. A 1.7% growth rate would add 0.2 points to real GDP growth. (1.7 times the 14% business investment share of GDP equals 0.2).
Home Building: Residential construction grew in the second quarter in spite of some lingering pain from higher mortgage rates. Home building looks like it grew at a 4.9% rate, which would add 0.2 points to real GDP growth. (4.9 times the 4% residential construction share of GDP equals 0.2).
Government: Only direct government purchases of goods and services (not transfer payments) count when calculating GDP. We estimate these purchases were up at a 1.7% rate in Q2, which would add 0.3 points to the GDP growth rate (1.7 times the 17% government purchase share of GDP equals 0.3).
Trade: Looks like the trade deficit expanded in Q2, as exports grew but imports grew much faster. In government accounting, a larger trade deficit means slower growth, even if exports and imports both grew. We’re projecting net exports will subtract 0.8 points from real GDP growth.
Inventories: Inventory accumulation looks like it picked up in Q2 relative to Q1, translating into what we estimate will be a 0.8 point addition to the growth rate of real GDP.
Add it all up, and we get a 2.1% annual real GDP growth rate for the second quarter. Good news compared to a recession but not a great starting point if a tighter monetary policy starts to bite harder.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
M2 Slowdown Finally Gaining Traction
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 07/16/2024
The lags between a shift in monetary policy and the economic impact are long and variable. While the actions of the Federal Reserve during the pandemic were unprecedented, it finally looks like the excess money pumped into the economy has worked its way through the system. And with the M2 measure of the money supply down from its peak, the economy is reacting.
This measure of the money supply surged in 2020-21 in the first two years of COVID as the government massively increased deficit spending and enacted temporary tax cuts that didn’t improve the long-term incentives to work, save, and invest. The resulting spike in inflation in 2021-22 certainly didn't surprise us, and it should not have surprised anyone else.
Yet it did. Many went out of their way to find other things to blame for inflation. They ignored M2, and blamed “Putin” or “supply chains” and called inflation “transitory.”
Sure, some prices were boosted by the lockdowns and war, but that was only a small fraction of the problem. If it was the whole problem or most of it, we wouldn’t be sitting here more than four years later with the consumer price index up 3.0% from a year ago. If it were all “transitory,” we should have seen a widespread drop in consumer prices, and that didn’t happen.
The Fed itself continues to ignore the money supply. Fed officials never bring up the topic on their own and reporters rarely if ever ask about it. And on the rare occasion when Fed Chairman Jerome Powell is asked about the money supply, he goes out of his way to say it’s not something the Fed pays much attention to.
However, the link between money and inflation is starting to get some more attention. A recent paper by Greg Mankiw, an academic economist who was the chairman of the Council of Economic Advisers under President George W. Bush, noted that forecasts of high inflation that were made back in 2021 that considered the M2 surge turned out to be right. (Note: the First Trust economics team won an award as the most accurate economists for the US economy for 2022, and we recognized the importance of the M2 surge.)
Which brings us to where the economy is right now. Consumer prices declined 0.1% in June, the largest drop for any month since the early days of COVID. Much of this was due to a drop in energy prices, but even “core” consumer prices were soft, up only 0.1% for the month, the smallest increase for any month in more than three years.
Meanwhile, we are seeing some softness in economic growth. Overall retail sales in May were no higher than in December (after adjusting for normal seasonal variation) and it looks like retail sales fell in June (to be reported Tuesday). Manufacturing production is likely lower than a year ago (reported Wednesday).
Considering that the M2 measure of money peaked roughly two years ago, this should not be surprising. The drop in M2 from early 2022 through late 2023 appears to be finally having an effect.
The wild card is that M2 is up at a modest 2.3% annual rate since last October. If this keeps up, a soft landing is possible while inflation continues to move back down to the Fed’s target. It could also leave room for some rate cuts by the Fed. By contrast, if the M2 money supply resumes a decline, that would raise the risk of a recession and if M2 surges again, it could herald a revival of inflation like we had in the 1970s.
Either way, we are glad the M2 money supply is starting to get more attention, we still follow it closely, and think investors should pay attention, as well.
The lags between a shift in monetary policy and the economic impact are long and variable. While the actions of the Federal Reserve during the pandemic were unprecedented, it finally looks like the excess money pumped into the economy has worked its way through the system. And with the M2 measure of the money supply down from its peak, the economy is reacting.
This measure of the money supply surged in 2020-21 in the first two years of COVID as the government massively increased deficit spending and enacted temporary tax cuts that didn’t improve the long-term incentives to work, save, and invest. The resulting spike in inflation in 2021-22 certainly didn't surprise us, and it should not have surprised anyone else.
Yet it did. Many went out of their way to find other things to blame for inflation. They ignored M2, and blamed “Putin” or “supply chains” and called inflation “transitory.”
Sure, some prices were boosted by the lockdowns and war, but that was only a small fraction of the problem. If it was the whole problem or most of it, we wouldn’t be sitting here more than four years later with the consumer price index up 3.0% from a year ago. If it were all “transitory,” we should have seen a widespread drop in consumer prices, and that didn’t happen.
The Fed itself continues to ignore the money supply. Fed officials never bring up the topic on their own and reporters rarely if ever ask about it. And on the rare occasion when Fed Chairman Jerome Powell is asked about the money supply, he goes out of his way to say it’s not something the Fed pays much attention to.
However, the link between money and inflation is starting to get some more attention. A recent paper by Greg Mankiw, an academic economist who was the chairman of the Council of Economic Advisers under President George W. Bush, noted that forecasts of high inflation that were made back in 2021 that considered the M2 surge turned out to be right. (Note: the First Trust economics team won an award as the most accurate economists for the US economy for 2022, and we recognized the importance of the M2 surge.)
Which brings us to where the economy is right now. Consumer prices declined 0.1% in June, the largest drop for any month since the early days of COVID. Much of this was due to a drop in energy prices, but even “core” consumer prices were soft, up only 0.1% for the month, the smallest increase for any month in more than three years.
Meanwhile, we are seeing some softness in economic growth. Overall retail sales in May were no higher than in December (after adjusting for normal seasonal variation) and it looks like retail sales fell in June (to be reported Tuesday). Manufacturing production is likely lower than a year ago (reported Wednesday).
Considering that the M2 measure of money peaked roughly two years ago, this should not be surprising. The drop in M2 from early 2022 through late 2023 appears to be finally having an effect.
The wild card is that M2 is up at a modest 2.3% annual rate since last October. If this keeps up, a soft landing is possible while inflation continues to move back down to the Fed’s target. It could also leave room for some rate cuts by the Fed. By contrast, if the M2 money supply resumes a decline, that would raise the risk of a recession and if M2 surges again, it could herald a revival of inflation like we had in the 1970s.
Either way, we are glad the M2 money supply is starting to get more attention, we still follow it closely, and think investors should pay attention, as well.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
How Strong is the Labor Market?
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 07/08/2024
We aren’t naturally cynical about economic data, but there are things that don’t add up about the job market.
On the surface, Friday’s report was solid, with nonfarm payrolls up more than 200,000 in June, another good month. However, downward revisions to the prior two months reduced the net gain in total payrolls to just 95,000, with a net gain of only 50,000 for the private sector.
Now for the strange parts. Nonfarm payrolls are up 2.6 million versus a year ago. But civilian employment, an alternative measure of jobs that includes small business start-ups is up a grand total of only 195,000 in the past year! Not 195,000 per month, but a total of just 195,000 over the past twelve months. Weird, right?
It's entirely possible that one of the major reasons for this gap is the recent surge in immigration. Immigrants who get jobs at one of the companies included in the payroll survey should be counted because it is filled out by employers. But the civilian employment figures (the weak one) are based on a survey of individual households and it’s hard to survey households in the US that are brand new or that are skittish about filling out a survey sent by the government, particularly if they are here illegally.
It's also important to point out that a gap between the two surveys this large may be highly unusual, but it has happened before. As a share of the labor force, the gap was briefly larger in the mid-1980s, the late 1990s, in 2013, and during COVID
Another oddity is the consistent negative revisions for the past few years. Back in 2022, the third report for payrolls for a particular month averaged 6,000 less than the initial report for that month. For 2023, the revisions averaged -30,000. So far this year they’ve averaged -49,000. In the past few decades, negative revisions are more likely to happen around recessions than when growth is strong. So maybe it’s a symptom of weakness to come.
But there’s also a more benign explanation. Remember, the payroll report is based on a survey of employers. In the ten years prior to COVID, the government was getting an on-time response rate of 75% from the employers it surveys; but in the past three years the timely response rate has averaged only about 65%.
So maybe the companies that don’t fill out the survey on time for the first payroll report are having more business trouble than their peers (compared to normal). A struggling company would have more important issues to deal with than filling out a government survey. Eventually, the statisticians will get used to that pattern and make adjustments, but the data are looking funny in the meantime.
Another oddity is the gap between full-time and part-time jobs. The civilian employment report shows full-time jobs down 1.6 million in the past year while part-time is up 1.8 million. That kind of loss of full-time positions is normally linked to a recession and declining payrolls, not continued strong economic growth.
Do these anomalies show the government is cooking the books? We wouldn’t go that far. If the Labor Department is cooking the books, presumably for political reasons, then why are they letting the unemployment claims reports show an increase and why don’t they cook the civilian employment report to show more job gains closer to what the payroll report shows?
The problem is that it’s hard to argue at this point that government officials haven’t abused their authority to advance a narrative they’ve found useful, including the “slam dunk” case for Iraq having Weapons of Mass Destruction, or COVIDs “six-foot” rule, school closings, and masks, or even whether the measure of deaths from COVID were “from” COVID or “with” COVID. It’s not just the CDC and NIH that have lost luster in the eyes of average investors, but other government agencies as well. More people are skeptical of government reports than we have seen in our careers.
Putting it altogether, we think the job market is poised somewhere between the still strong picture painted by the payroll report and the soft reports on civilian employment. No recession yet, but some early signs of a slowdown.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
America's 3.5-Second Miracle
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 07/01/2024
In 1852, Karl Marx said "Men make their own history, but they do not make it as they please; they do not make it under circumstances chosen by themselves, but under circumstances directly encountered and transmitted from the past."
He, obviously knew about the Magna Carta (1215) and the English Parliament’s Bill of Rights (1689), which created a separation of powers between the King and elected representatives. What he didn’t pay much attention to was how the United States had improved upon these documents or he would have seen a country of entrepreneurs that had freedom and property rights along with a constitution so well thought out that it has only been amended twenty-seven times in 235 years. No one puts it better than Ronald Reagan; the excerpt below comes directly from his Commencement Address at the University of Notre Dame back on May 17, 1981.
"This Nation was born when a band of men, the Founding Fathers, a group so unique we've never seen their like since, rose to such selfless heights. Lawyers, tradesmen, merchants, farmers – fifty-six men achieved security and standing in life but valued freedom more. They pledged their lives, their fortunes, and their sacred honor. Sixteen of them gave their lives. Most gave their fortunes. All preserved their sacred honor.”
“They gave us more than a nation. They brought to all mankind for the first time the concept that man was born free, that each of us has inalienable rights, ours by the grace of God, and that government was created by us for our convenience, having only the powers that we choose to give it. This is the heritage that you're about to claim as you come out to join the society made up of those who have preceded you by a few years, or some of us by a great many.”
“This experiment in man's relation to man is a few years into its third century. Saying that may make it sound quite old. But let's look at it from another viewpoint or perspective. A few years ago, someone figured out that if you could condense the entire history of life on Earth into a motion picture that would run for 24 hours a day, 365 days – maybe on leap years we could have an intermission – this idea that is the United States wouldn't appear on the screen until 3.5 seconds before midnight on December 31st. And in those 3.5 seconds not only would a new concept of society come into being, a golden hope for all mankind, but more than half the activity, economic activity in world history, would take place on this continent. Free to express their genius, individual Americans, men and women, in 3.5 seconds, would perform such miracles of invention, construction, and production as the world had never seen.”
America has proven that men and women not only can make their own history, but they can make it as they please, with circumstances chosen by themselves. Happy 4th of July to you all. Let’s take time this week to step back and realize just how fortunate we are to live in a time and place where the fire of invention still burns hot, course corrections (however messy they may be) still take place, and the future remains as bright as ever. May we continue to honor the legacy of those who came before us by striving to uphold the principles that have made this country a beacon of hope and freedom for the world. (We first published a version of this same Monday Morning Outlook in celebration of July 4th, 2023.)
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Lessons Not Learned
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 06/24/2024
Back in the early days of COVID, there was one key indicator that signaled or predicted the high inflation ahead: the M2 measure of the money supply. Unlike in the aftermath of the Financial Panic and Great Recession of 2008-09, M2 surged at an unprecedented pace in 2020-21.
So, while others looked back and said “QE doesn’t cause inflation” we didn’t. While many said that inflation was “transitory,” we warned about inflation going higher and being more persistent. And here we are more than four years past the onset of COVID and inflation is still lingering above the pre-COVID trend. The Consumer Price index is up 3.3% from a year ago while core consumer prices are up 3.4%.
What we take from all of this is that many economists, investors and policymakers ignored M2 to their detriment. As a result, they have been surprised by the surge and persistence of inflation. You think they might have learned.
But now a new conventional wisdom has taken hold, which says the US is out of the woods on a potential recession. This, in their view, supports a trailing price-to-earnings ratio of 24 on the S&P 500, a level that in the past has been associated with low future returns on equities.
We hope a recession doesn’t happen, but think their dismissive attitudes towards warning signs like M2 (which has declined in the past 18 months) increases the chances they get caught flat-footed by a downturn. We know it’s not visible yet, but every once-in-a-while there’s an economic report that should make people re-think their pre-conceived notions.
That applies to home building in May. Out of the blue, housing starts dropped 5.5%, completions fell 8.4%, and permits for future construction declined 3.8%.
Housing starts and permits are now sitting at the lowest levels since the early days of COVID, even as the flow of immigration remains elevated. Whether you support or oppose high levels of immigration, where are all the newcomers going to live if we aren’t building more housing? And isn’t one of the arguments in support of high immigration that industries like home construction need cheap labor to build more homes?
In the meantime, retail sales surprised to the downside in May, eking out only a 0.1% gain for the month, but including revisions to prior months were actually 0.3% lower. Retail activity is roughly unchanged since the end of last year, which means after adjusting for inflation, consumers are buying fewer goods. Car sales rose slightly in May, but are down from last December and even down from June 2023.
In addition there’s an early sign that the labor market may have some trouble ahead: initial claims for unemployment insurance averaged 211,000 per week in the fourth quarter of 2023, as well as the first quarter of 2024. But initial claims have averaged about 240,000 in the past two weeks. Hopefully this is just some seasonal variation and claims will go back down soon, but it is worth watching closely in the weeks ahead. (One caveat is Thursday’s initial claims report will include Juneteenth, a relatively new holiday which may confuse seasonal adjustments.)
None of this means a recession has already started. Industrial production surged 0.9% in May, which is not a recessionary number at all. The Atlanta Fed GDP Model is back up to tracking 3.0% annualized growth in Q2, while we are tracking 2.0%. And private payrolls continue to average over 200,000 jobs added per month, even if gains appear to have been led by part-time positions.
It's also important to recognize that fiscal policy has never been this “loose” (the deficit so high) when the unemployment rate has been so low. But with the interest burden on the federal debt as a share of GDP suddenly shooting up to the highest since the 1980-90s, the days of using the budget to try to artificially boost growth should soon come to an end.
There’s no guarantee of a recession in the year ahead, but the risk shouldn’t be casually dismissed. Not paying attention to M2 has cost investors more than once already.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Spotlighting Inequality
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 06/17/2024
Last week, Donald Trump proposed replacing the income tax with a tariff on imports. Washington DC let out a loud, and collective, scoff. The average American was intrigued. More on this in a few…but to be clear, the idea as it stands won’t work in our current system. The US cannot replace income tax revenues without sky-high tariffs, and sky-high tariffs would shut down world trade. Remember…much lower Smoot-Hawley tariffs in 1930 helped kick off the Great Depression.
But that doesn’t mean we shouldn’t use this as a starting point for discussion. Have you followed Elon Musk and SpaceX? Specifically, the Starship, which just had its fourth launch? Well, what we are witnessing is the process of iterative development. Each launch has gone further and had more success. Henry Ford did the same thing with the automobile and assembly lines.
This process of iterative learning, which is prevalent in the private sector, seems non-existent in government. To use an example that writer Glenn Harlan Reynolds shared in a recent Substack post: Ad Astra, Per Ardua, the Space Shuttle was supposed to be reusable, but it never truly was – it cost over $1 billion per flight. Musk, on the other hand, by figuring out how to re-use boosters has driven the cost per flight down to the range of $3-5 million.
The cost to put a kilogram of payload in space was $55,000 in the Shuttle but is only $2,700 in a SpaceX Falcon 9, a 20-fold reduction. And this cost will keep coming down. It’s an amazing thing to watch, how the private sector can simply crush government in efficiency and progress.
Which takes us back to Donald Trump’s proposal to scrap the income tax and replace it with tariffs on imports. If you look at this proposal like the permanent fixtures of the Beltway do, it’s absolutely ludicrous. Paul Krugman (on X) couldn’t resist running all the numbers, showing how the tariff would have to rise to 133%, or higher, to raise the same revenue.
At least he admitted that in the 1800s the US funded itself with tariffs and excise taxes, but that was when the federal government was significantly smaller. Instead of wondering if we could run the government like SpaceX, and not NASA, he just said anyone who thinks we can shrink government that much is just plain “ignorant.” For the record, calling people ignorant is not proving them wrong. It is rude, though.
Krugman comes from the left, but even those on the right said Trump’s idea was crazy. Most used the same logic as Krugman. Inside the Beltway, the only way to look at anything is to use static scoring models, and very little imagination. Social Security can’t be imagined anew, bureaucracies are entrenched and have decades of momentum. They have no incentive to become more productive or to learn iteratively. Doing so means fewer jobs and smaller budgets. There is no profit incentive at all…government cannot possibly think like the private sector, even though it should.
At least Donald Trump is thinking outside the Beltway Box. The pundits are right, taxing just imports would increase the deficit “hugely” to use his word. We have no idea if that’s what he was thinking. We doubt it, but it takes an idea to lead to iterative thinking. Science fiction writer, Steve Stirling, wrote about Starship: “That's what iterative development does; you don't try to make it perfect the first time. You make it 'good enough for a first try', push it until it breaks, fix what broke, try again, and again and again... until it works all the way.”
One could argue that government keeps trying to iteratively learn. But Great Society programs have led to several generations of welfare and apparently permanent poverty. Programs to fix inequality led to more of it, public schools (especially in inner cities) have failed, Social Security will run out of money in 2033, the Federal Reserve has a $1 trillion loss on its books and has to borrow money to make payroll. The government is so big that even Sports Illustrated, ESPN, and the Weather Channel can’t help but talk about politics.
The problems the US has today are no different than the problems the US had in the 1960s or the 1930s. One could actually argue that they are worse even though government has grown and grown. So, this proposal by Donald Trump is a breath of fresh air. Instead of immediately declaring it dead-on-arrival, why don’t we take this opportunity to discuss the size of government, and how we pay for it.
We know it’s more comfortable for the Beltway crowd to just move on…don’t rock the boat…analyze the same things the same way as always. We, on the other hand, are going to take this opportunity to grab this idea by the horns and discuss it in the context of history, and the current state of affairs in the US.
The Founders did not have an income tax to fund government, that wasn’t instituted until 1913. What they could do was use excise (sales) taxes and tariffs. In the 19th century, actually up through 1930, the peacetime government spent less than 3% of GDP. Today, federal spending is roughly 23% of GDP, while state and local governments spend about 14% of GDP on goods and services. Add in the cost of complying with government rules and regulations and we estimate the government either spends, or directs to be spent, roughly 50% of our annual output.
The private sector can’t afford it…that’s why federal deficits alone are running nearly $1.7 trillion per year, with no end in sight. State debt and unfunded pension liabilities have also grown exponentially. Clearly something is broken, but bureaucrats, lobbyists, politicians, and think tank employees go to work every day and color inside the lines. Every once in a while someone comes up with a new idea, which immediately gets crushed by vested interests.
A couple of things. It is clear China has used existing tariffs and global trade to dominate markets in all kinds of areas. The US would have a tough time, today, producing all the pharmaceuticals, ammunition, batteries, and many other items it needs without trade. We believe trade is a positive for economic growth; we are free traders. However, we are also realists that understand not all our trading partners have our best interests at heart. Counting on imports for our national security is a risk that few talk about.
Second, roughly 40% of Americans don’t pay income taxes. The income tax system has become so progressive that 97.7% of the taxes are paid by the top 50% of income earners. In other words, half of America has no, or little, skin in the game when it comes to income taxes. As a result, top tax rates (along with deductions, etc.) are likely higher than they would be if everyone paid the tax. When there is no pain to you why care what others have to pay? And to all those who say tax rates don’t matter, just look at all the people and businesses leaving California, Illinois, and New York.
A tariff is a tax on consumers because it will be passed on. In other words, it’s a form of a consumption, or sales, tax. Just about every state has one. So, this idea to replace income taxes with tariffs is a step toward a consumption tax. Some say this tax is regressive because low-income earners spend more of their income than high income earners. But this can be dealt with and, don’t forget, high-income earners (or their heirs) eventually spend their savings and therefore pay consumption taxes in the future. If everyone has to pay, then maybe voters will look differently at how government spends.
It seems clear that if we step back, look at the size of federal, state, and local government debts – the fact that after trillions in spending we have not really improved poverty, nor have we addressed the inefficiencies in government – the system is broken. Maybe some kind of iterative process of change is the only way to break the cycle. As a result, we think immediately scoffing at a new proposal is wrong.
We rarely write more than one page but found this idea to be so amazingly new that we couldn’t help it. It is time for America to have a discussion about how much it spends and how it pays for it. Maybe, just maybe, Donald Trump has started that discussion. If so, we will be better for it.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Spotlighting Inequality
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 06/10/2024
With a Presidential election less than five months away, expect to hear a great deal of discussion about inequality: the gap between the rich, the poor, and the middle class.
It’s been a recurring theme of pretty much every presidential election starting in 1932, if not before. What should the federal government itself do to address poverty, expand opportunities for the poor, and close the gap between the rich and poor? It’s a potent political talking point, large parts of government spending, along with many agencies and programs, are designed to address it. Inflation, immigration, record-high corporate profits, and soaring stock markets are in the spotlight.
Joe Biden proposes student loan debt forgiveness and caps on drug prices, while Donald Trump has said he will end the taxation of tip income for service workers. These policies are focused on relieving financial burdens on specific groups.
More importantly, if we look at the results of policies during COVID (massive monetary and fiscal stimulus), it is clear that those who own assets benefited, while those who do not, were harmed. Those who had accumulated assets of various kinds – stocks, bonds, real estate, crypto,…etc. – have benefited from asset price inflation, particularly those whose jobs allowed them to work remotely.
This same inflation caused by the Federal Reserve hit lower income groups harder than everyone else. It’s a given that those with fewer financial assets benefited less from price appreciation. And while average hourly earnings did accelerate because of inflation…up 22.3% since February 2020, the consumer price index is up 20.8% during that same time frame. But, food prices are up 25.3% and energy prices are up 35.6%, both of which make up a larger share of spending for lower income groups. Airfare, by contrast, is down 1.2% over the same timeframe. No matter how we look at it, living standards have at best stagnated for those with few assets and wage income.
Politicians have pushed for an increase in the minimum wage to try to help lower-income workers keep pace with inflation, but we doubt that’s helping. For example, in California a recent law raised the minimum wage for restaurant workers to $20/hour versus $16/hour for other workers.
Overall unemployment remains low at 4.0%, up only 0.3 percentage points from a year ago. But that overall modest increase masks some large increases among younger workers. Unemployment among 16-17 year-olds has soared to 13.6% from 9.7% a year ago. Unemployment among 20-24 year-olds has risen to 7.9% versus 6.3% a year ago. The kids are increasingly not alright in the current labor market.
And no matter how much time politicians spend talking about inequality, too small a share of it will be spent discussing the horrible long-term effects of COVID Lockdowns on learning, which caused a loss of accumulated skills during COVID itself but also the lingering effects of higher school absenteeism.
One way to address educational inequality is for states to continue to move in the direction of funding students rather than funding government-run schools. After all, even in states with locked-down public schools, many private schools found a way to educate students in person. Because most state governments fund schools and not students, those who could afford private schools avoided a good deal of the learning loss.
Meanwhile, lurking in the background, is the issue of the huge number of low-skilled workers coming across the border in the past few years. Obviously, the people coming to the US will be able to earn more here than in their home countries.
But whether or not this immigration is overall “good” or “bad” for the US economy, low-skilled immigration almost certainly benefits higher-income natives, who, don’t have to compete in the labor market against newcomers, much more so than the low-income Americans, who often do have to compete.
The fact that all these problems became worse during COVID is ironic. Many politicians believe the real source of inequality is capitalism itself, with America as the poster-child. But in the US, during COVID, government (including the Fed) became bigger and more powerful than ever, while living standards stagnated for those who had not accumulated assets.
The real, and only proven, way to create less inequality is to allow free market capitalism to work. Interfering in that process creates more problems than it solves.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Waiting on the Fed
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 06/04/2024
One of our main contentions in recent months is that the Federal Reserve, by switching from a scarce reserve model to an abundant reserve model, has completely taken over the short-term interest rates marketplace.
The Fed’s balance sheet has expanded from $870 billion in August 2008 to $7.2 trillion today, a staggering 733% increase, and has averaged 33% of GDP over the past four years, bigger than at any time in history. It’s the 1000 lb. gorilla in the room.
What this means is that the markets are not necessarily focused on economic data itself but are trying to figure out what Jerome Powell and the Fed think about the data. Not long ago, the market was pretty convinced the Fed would cut rates five or six times this year. Now, at the Fed’s meeting next week, there’s basically zero chance that it’ll cut rates at that meeting, or at their late July meeting either.
The lack of rate cuts by the Fed makes sense given the recent lack of progress on inflation. During the year ending in April, the consumer price index rose 3.4%, which is an acceleration from the 3.0% increase during the year ending in June 2023. It looks like consumer prices rose only 0.1% in May, but even with that small monthly increase, the year-to-year gain would come in at about 3.3%, still higher than in mid-2023.
The Fed focuses on other measures of inflation. One, the PCE deflator, is now up 2.7% from a year ago. But it wasn’t that long ago that the Fed told markets and investors that they need to focus on something called “Supercore” inflation, which is PCE prices excluding food, energy, other goods, and housing. That measure is up 3.4% from a year ago and has accelerated lately, including up at a 4.1% annual rate in the past six months. No wonder the Fed stopped talking about Supercore inflation; it doesn’t fit the narrative. And by downplaying this measure, the Fed is signaling that it wants to find a reason to cut.
Meanwhile, the Cleveland Fed’s measure of median PCE inflation is at 3.3% and the Dallas Fed’s measured of “trimmed mean” PCE inflation is 2.9%. None of these are very close to the Fed’s supposed 2.0% target. Maybe this is why the “inside baseball” discussions deep in the Fed, and elsewhere, are saying maybe we should raise the target inflation rate to 3.0%. Once again, signaling a desire to cut rates in this election year.
At the Fed’s meeting in March, members published their anonymous forecasts in a “dot plot” that suggested two or three rate cuts this year. The market is less sure, and when the Fed publishes the next set of dot plots, we expect one or two rate cuts, instead. This makes sense. The economy is growing, inflation is stubborn, jobs are being added and stock markets are strong. Why would the Fed cut rates at all?
The answer is we don’t know what the Fed is thinking, and rather than base forecasts on economic fundamentals, and bank demand for capital, forecasting the Fed has become a guess about motivations. In other words, at the center of financial capitalism these days is what we believe is an unhealthy obsession with the decisions of a government agency.
Long-term, what will drive markets is the process of innovation, entrepreneurship, and, ultimately, profits. AI certainly doesn’t seem worried about rates. Keep that in mind when you hear about next week’s Fed meeting, whether it brings surprises or not. What’s worrying: centrally planned economies always look like they are working, until they don’t.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
Waiting on the Fed
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 06/04/2024
One of our main contentions in recent months is that the Federal Reserve, by switching from a scarce reserve model to an abundant reserve model, has completely taken over the short-term interest rates marketplace.
The Fed’s balance sheet has expanded from $870 billion in August 2008 to $7.2 trillion today, a staggering 733% increase, and has averaged 33% of GDP over the past four years, bigger than at any time in history. It’s the 1000 lb. gorilla in the room.
What this means is that the markets are not necessarily focused on economic data itself but are trying to figure out what Jerome Powell and the Fed think about the data. Not long ago, the market was pretty convinced the Fed would cut rates five or six times this year. Now, at the Fed’s meeting next week, there’s basically zero chance that it’ll cut rates at that meeting, or at their late July meeting either.
The lack of rate cuts by the Fed makes sense given the recent lack of progress on inflation. During the year ending in April, the consumer price index rose 3.4%, which is an acceleration from the 3.0% increase during the year ending in June 2023. It looks like consumer prices rose only 0.1% in May, but even with that small monthly increase, the year-to-year gain would come in at about 3.3%, still higher than in mid-2023.
The Fed focuses on other measures of inflation. One, the PCE deflator, is now up 2.7% from a year ago. But it wasn’t that long ago that the Fed told markets and investors that they need to focus on something called “Supercore” inflation, which is PCE prices excluding food, energy, other goods, and housing. That measure is up 3.4% from a year ago and has accelerated lately, including up at a 4.1% annual rate in the past six months. No wonder the Fed stopped talking about Supercore inflation; it doesn’t fit the narrative. And by downplaying this measure, the Fed is signaling that it wants to find a reason to cut.
Meanwhile, the Cleveland Fed’s measure of median PCE inflation is at 3.3% and the Dallas Fed’s measured of “trimmed mean” PCE inflation is 2.9%. None of these are very close to the Fed’s supposed 2.0% target. Maybe this is why the “inside baseball” discussions deep in the Fed, and elsewhere, are saying maybe we should raise the target inflation rate to 3.0%. Once again, signaling a desire to cut rates in this election year.
At the Fed’s meeting in March, members published their anonymous forecasts in a “dot plot” that suggested two or three rate cuts this year. The market is less sure, and when the Fed publishes the next set of dot plots, we expect one or two rate cuts, instead. This makes sense. The economy is growing, inflation is stubborn, jobs are being added and stock markets are strong. Why would the Fed cut rates at all?
The answer is we don’t know what the Fed is thinking, and rather than base forecasts on economic fundamentals, and bank demand for capital, forecasting the Fed has become a guess about motivations. In other words, at the center of financial capitalism these days is what we believe is an unhealthy obsession with the decisions of a government agency.
Long-term, what will drive markets is the process of innovation, entrepreneurship, and, ultimately, profits. AI certainly doesn’t seem worried about rates. Keep that in mind when you hear about next week’s Fed meeting, whether it brings surprises or not. What’s worrying: centrally planned economies always look like they are working, until they don’t.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
Housing Update
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 05/28/2024
Two reports on home prices arrived this morning, one for the Case-Shiller index and another from the FHFA (a government agency that regulates Fannie Mae and Freddie Mac). Both rose in March, and housing prices are up 6.5% and 6.8%, respectively, in the past year.
We think price gains will continue in the year ahead, although not every month, and probably at a slower pace than seen over the past year. Just like very loose monetary policy back in 2020-21 permanently lifted the general price level for goods and services – most of the home price gains during that period will likewise end up being permanent. Some regions around the country (for example Naples, FL) exceeded those gains because of the peculiar dynamics of COVID. They are therefore vulnerable to some pullback, but we are not in a bubble like we saw prior to the financial crisis of 2008-09.
Through March, the Case-Shiller index is up 47.4% and the FHFA index is up 50.2% compared to February 2020 (pre-COVID). Meanwhile, the Consumer Price Index through March was up 20.4% vs February 2020 levels. But other factors are at work in the housing market. For example, over the same period the price index specific to constructing new single-family homes was up 37.9% as commodity and labor costs rose, outstripping general inflation.
Just as important is the lack of supply in the housing market. Homebuilders haven’t been making enough homes since the bursting of the housing bubble. Back in 2009-2015, this made sense: the best way to clear out the excess inventory of homes was to build fewer homes than would normally be needed to meet population growth and scrappage (fires, floods, knockdowns…etc.). But that excess supply was absorbed almost a decade before COVID, and yet builders kept underbuilding.
Don’t get us wrong, we’re not blaming the builders themselves or capitalism. Governments – federal, state, and local – have created extensive regulations on home construction, making it harder and more expensive to build. Environmental rules, zoning limits, historical preservation, the promotion of “smart growth” or “affordable housing” all impede a free market. On top of this, small businesses (which include many home builders) face incredibly complex and burdensome hurdles in managing payrolls, including taxes, rules, and regulations. COVID era policies widened the performance gap between small and big business.
Meanwhile the construction process itself is taking longer. Prior to COVID, the average time from permit to start for single-family homes was 1.1 months; in 2023 (the latest available) it was 1.5 months. This increase was led by the Northeast, where the average time went from 0.9 months prior to COVID to 2.1 months in 2023. For multi-family homes, it used to take 1.9 months from permit to breaking ground, now it's 2.8 months.
Finishing a home that’s been started is also taking longer, now 8.6 months for single-family homes versus 7.0 months pre-COVID. Multi-family construction was taking 15.4 months pre-COVID, now it’s 17.1 months.
No wonder new home sales continue to languish below where they were in 2019. Existing home sales are far below the 2019 pace, too, although much of that is due to “mortgage lock-in,” where homeowners borrowed at very low rates during COVID and now don’t want to move come hell or high water.
Making the housing situation even worse is that government policies that limit home construction are happening at the same time as a massive surge in immigration in the past few years. Whatever you think about our current border situation, the greater the flow of immigration, the more you should support looser restrictions on building homes. If we’re going to have an open border, a free market in housing is more essential than ever.
To summarize, housing prices may rise a little slower, and if we do see a recession, sales will slow as well, but because of underbuilding the housing market overall will likely remain more resilient in any downturn than it has in the past.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Are Abundant Reserves Paying for the CFPB?
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 05/20/2024
Back in 2008, the Federal Reserve made important changes in the way it handles monetary policy. We’ve written about them several times, but few really understand. The press won’t ask questions about it and few economists discuss them. They seem nuanced and arcane, and they are, but they are also massively important, and potentially dangerous.
With Quantitative Easing, the Fed shifted from a scarce reserve model to an abundant reserve model. The flood of new money grew the Fed’s balance sheet from $870 billion in August 2008 to its current level of $7.4 trillion. That’s a 747% increase. The Fed was just 5% of the size of the economy in 2008, today it exceeds 25%.
In order to contain the potential inflation from all this money the Fed has raised banks’ capital requirements and increased liquidity demands. Despite being flush with reserves, banks are constrained in making loans, holding three to four times more reserves as a share of deposits than they did in 2007 before all these changes happened.
One result of this is that banks no longer trade federal funds. They don’t need to because they all have excess reserves, the system as a whole is flooded with them.
When banks had scarce reserves, interest rates were a signal about the demand for money because banks borrowed and lent reserves every day. With reserves now piled everywhere, there is no market for federal funds and the Fed sets rates wherever it wants them…with or without regard to the demand for money.
Because the Fed is a creature of Washington DC, political pressure plays a role. And, when it comes to politics, low rates are better than high rates. Not for savers, but for car loans or mortgages and also for a government running large deficits.
As a result, the Fed has held interest rates below inflation 80% of the time since 2008, and at roughly 0% for nine out of the past fifteen years. This policy is now creating real problems. Everyone got used to low interest rates; banks acted like they would last forever and made loans or bought bonds at artificially low interest rates. But QE and an abundant reserve policy were playing with fire. With all that money in the system, an inflationary mistake was inevitable.
And with higher inflation comes higher interest rates. So, to put this in historical perspective, a policy (QE) that was implemented in order to counteract less than $400 billion in losses from subprime loans has created unrealized losses on bank balance sheets of more than $680 billion as of Q3 2023 (and the Fed itself has seen unrealized losses on their own balance sheet approach $1 trillion). When rates rise, the value of loans and bonds falls. It’s why we are seeing bank failures these days.
The key difference is that in 2008, the US was enforcing mark-to-market accounting. This caused a relatively small problem to become a massive problem, a panic. Today, banks don’t have to mark those losses to market and the system is much more stable. But please don’t ignore the fact that we have nearly double the losses on bank books today than we did in 2008.
Another problem with this new policy is that the Fed bought the same bonds the banks did during the low-rate environment. And because the Fed decided to pay banks to hold reserves, it is now paying more in interest to banks than it is earning on the bonds in its portfolio.
We have asked many times before: if the Fed is losing $100 billion dollars a year, how does it pay its staff? Apparently, the answer is: by borrowing from the Treasury with a promise to repay when it makes profits in the future. In other words, the taxpayer is now footing the bill for this new method of managing monetary policy.
And that brings us to our final point. The Supreme Court ruled last week that the Consumer Finance Protection Bureau (CFPB), by a vote of 7-2, could remain an independent agency even though it wasn’t funded by Congress like other agencies, but instead by the Fed.
The problem with the Court’s logic is that the Federal Reserve is now losing money every day. The only way it can pay for the CFPB is to use taxpayer money by borrowing directly from the Treasury. So, the CFPB is deemed “independent” because it doesn’t rely directly on Congress for funding, but in reality it is spending taxpayer funds when the Fed runs losses.
But even if the Fed were making a profit, (as it was when it was paying banks 0% on reserves while earning money on its portfolio of bonds) and remitting that money to the Treasury, it would be holding back funds in order to pay for the CFPB. In other words, no matter how you cut it, the Fed ultimately gets all its resources from the taxpayer…either through the cost of inflation, by remitting less to the Treasury, or by borrowing from the Treasury when it is not running a profit.
If the Supreme Court understood the complications of monetary policy, especially after the changes implemented in 2008, we would have expected a different ruling.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Would Trump Reignite Inflation?
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 05/13/2024
One theory making the rounds is that if President Trump gets back into office, inflation is going to surge. The idea is that if he returns, Trump will raise tariffs, reduce immigration, and jawbone the Federal Reserve to cut interest rates too much, all of which could push inflation higher, maybe even to where it was a couple of years ago when it peaked at 9.1%.
We are certainly not optimistic about the path of inflation in the decade ahead. The Consumer Price Index (CPI) went up at only a 1.8% annual rate in the ten years prior to COVID and we think it’ll be closer to 3.0% per year in the decade ahead. However, we think that’ll likely be the case regardless of the election results later this year. At the same time, we don’t expect anything like the COVID surge in inflation in the next few years.
Take the tariff argument, for example. Yes, tariffs would raise prices for the items being tariffed. But unless the Fed loosens monetary policy in response, the extra money consumers would have to spend on imported items would have to come from money they’d otherwise use to buy other items, putting downward pressure on prices for those other items and not changing overall inflation. Remember, Trump raised tariffs during his first term in office and yet inflation was subdued until the Fed ignited it during COVID.
The same goes for immigration, which was slower in the Trump Administration than it had been under President Obama, without causing a spike in inflation. By contrast, immigration has soared under President Biden while the CPI has averaged 5.6% per year. If immigration was some sort of magic that kept inflation low, why wasn’t inflation much higher during Trump and why hasn’t it been lower under President Biden?
We think this is ultimately because it’s monetary policy that determines inflation, not tariffs or immigration. Which brings us to the last argument suggesting Trump will bring back high inflation, that he will put political loyalists in charge of the Fed who will loosen policy much more than economic conditions suggest, leading to a spurt in inflation.
It is true that Trump would have the chance to put loyalists at the Fed, but the terms of Fed policymakers turn over gradually. Also, every nominee would need confirmation by the Senate. None of these people, not the nominee or nominators, would want to be blamed for causing a surge in inflation.
We are guessing Trump would appoint either Kevin Warsh or Kevin Hassett as Fed chairman to succeed Jerome Powell, neither of whom would want to go down in history as the second coming of the failed Arthur Burns of the 1970s. Moreover, many of the votes on monetary policy come from regional bank presidents not appointed directly by the president. The Fed is full of checks and balances, and part of a new Fed regime’s task will be to fix the inflationary tilt of policy since 2008.
Again, we are not saying inflation won’t be a problem in the years ahead; it likely will be. But it’s likely to be a problem no matter who wins this November.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
The Fed Faithful
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 05/06/2024
If the financial markets have a religion, we think we know what it is: a deep and abiding faith in the ability of an omniscient Federal Reserve to ride to the rescue if and when the economic weather turns bad.
It’s hard to tell exactly where the economy is right now, but it’s very unlikely to be in a recession or need a rescue yet. The Atlanta Fed’s GDP Now model is tracking 3.3% annualized growth in the second quarter, while our models suggest a growth rate of 2.5%. Both of these are above the 20-year average growth rate of 2.0%.
However, not all the economic signs are as positive. The ISM Services index came in at 49.4 in April, the first reading below 50.0 since December 2022. The business activity component, at 50.9, was the lowest since the onset of COVID in 2020. This is important to us because readings below 50 signal contraction. The ISM Manufacturing index came in at 49.2, the seventeenth month below 50.0 in the past eighteen months.
During COVID, services were locked down in many states for a long time, with many of those workers receiving checks from the government, which they in turn spent on goods. Since opening up, goods have been weak, while services have recovered. That process appears complete now, and the dip in services could signal problems.
It could also be why the labor market lost at least a little bit of luster in April, with slower job growth, slower wage growth, and fewer hours worked. Nonfarm payrolls grew 175,000 for the month, less than the 225,000 the consensus expected.
We like to follow payrolls excluding government (because it's not the private sector), education & health services (because it rises for structural and demographic reasons, and usually doesn’t decline even in recession years), and leisure & hospitality (which is still recovering from COVID Lockdowns). That “core” measure of payrolls rose a modest 67,000 in April, the slowest pace so far this year.
There are two measures of total jobs. One survey (which gave us the data we just mentioned for nonfarm payrolls) looks at existing establishments. The other measures civilian employment by talking directly to workers. It will catch self-employment and small-business start-ups. Last month this measure increased a weak 25,000 (and unemployment rose to 3.9%). Over the past year civilian employment is up 500,000 versus 2.8 million new jobs counted by the payroll survey. This divergence has happened before, but it is still slightly worrisome.
Nothing in the April jobs report suggest a recession, but it’s certainly a move in a more tepid direction versus the prior path of the labor market.
In the meantime, the Fed, as well as market expectations of what the Fed will do, keep bouncing around. On Wednesday the Fed made it clear that, in response to a string of relatively high inflation readings, the bar to cutting rates anytime soon (at least until July) is very high. Why? Consumer prices are up 3.5% in the year ending March, an acceleration from the 3.0% in the year ending in June 2023. Lack of progress on inflation makes it difficult for the Fed to justify rate cuts.
The Fed thinks the stance of monetary policy is already tight enough to eventually bring PCE inflation (its preferred measure) down to its 2.0% target, it’s just taking longer than previously expected.
In fact, the Fed must believe it is making progress on inflation because it announced that it would soon slow the pace of Quantitative Tightening. It will now reduce its portfolio of Treasury securities by $25 billion per month starting in June, less than half the previous rate of $60 billion per month since mid-2022. The Fed didn’t change the rate of reduction in mortgage-related securities, holding that target to “up to $35 billion per month,” which makes sense because paydowns have slowed with higher mortgage rates.
In effect, the Fed is moving toward a loosening of monetary policy, even as the Fed claims to be determined to fight inflation. No wonder the expectations surrounding shifts in short-term interest rates this year have bounced around so much, with the Fed thinking of its balance sheet, the money supply, and short-term rates as separate and distinct tools.
Ultimately, if the Fed is going to be successful on inflation, it’s going to need a monetary policy that’s tight enough to hurt real economic growth, as well. That should scare the stock market, and yet the stock market as a whole remains lofty relative to interest rates and profits. This only makes sense if investors believe the Fed will be able to react quickly to economic weakness once it kicks in, without reigniting inflation. Count us skeptical.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
inflation. Count us skeptical.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
The Worst Malinvestment
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 04/29/2024
Austrian Economics argues that growth comes from innovation and entrepreneurship, with “the market” directing resources to areas of the economy that provide the greatest returns. It also observes that when government uses interest rates, subsidies, taxes, or other types of market interference, it can cause “malinvestment” – or investment in areas that wouldn’t receive market support. This leads to losses and wasted resources.
While there are many examples of this as government has become bigger and more unaccountable, recent events on many college campuses around the US show some of the worst malinvestment our country experiences year in and year out.
Public universities certainly don’t run like capitalist institutions, but neither do private colleges (like the Ivy League). While people complain about all kinds of corporate welfare, what about university welfare? The eight Ivy League Schools, plus Northwestern and Stanford (all private) received $33.1 billion in grants and contracts from the federal government between 2018 and 2022 in data calculated by Open the Books.
Meanwhile, the government has given $1.6 trillion in “loans” to young people to buy the “services” of schools and their academics. Although these loans are sold as a good thing for young people, we think the main effect is to create jobs for and support the wages of academics who get to pocket the money whether their work leads to new inventions and innovation or a disdain for freedom, capitalism, and America itself.
Yes, it’s certainly true that most people with high-paying jobs have gone to college. But, as George Mason economist Bryan Caplan found, a college degree isn’t actually the cause. They earn more because they’re often highly intelligent, very conscientious, or willing to conform to a corporate culture. Sometimes all three! So unless you’re pursuing a degree in something where you need a specific body of knowledge, like medicine or engineering, going to college likely just signals natural intelligence, conscientiousness, and corporate conformity, not important knowledge.
In turn, Preston Cooper at FREOPP.org has researched about 30,000 bachelor’s programs around the county and found that more than 25% of programs experience a negative return on investment (ROI), which certainly helps explain why so many people feel burdened by student loans. And, going to a very selective school is no guarantee of a positive ROI.
We can’t help but wonder if these economic realities, and evidence of malinvestment, aren’t at least partly responsible for turmoil on college campuses. After all, malinvestment leads to slower long-term economic growth, which undermines growth in living standards. More debt and less growth are a recipe for bad outcomes.
We aren’t positive everyone will see it this way, but the data and reality on the ground seem to be saying the US ought to find a way to separate academia and government. One key item, which we have mentioned before, is that universities and colleges should be on the hook for all, or at least a portion, of unpaid student loans. And why does the federal government give billions to schools who have massive and un-taxed endowments? Any action, which reduces malinvestment, will lead to better outcomes for all.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Continued Growth in Q1
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 04/22/2024
The economy continued to grow in the first quarter at what we estimate is a 2.6% annual rate. That’s a slowdown from the 3.1% rate in 2023, but still good compared to the past couple of decades when the average growth rate has been 2.0%.
However, we think a chunk of recent growth is artificial, and temporary, the by-product of too much government. Directly, this includes “real” (inflation-adjusted) government purchases that grew 4.6% in 2023 and we estimate grew at a 2.3% annual rate in the first quarter.
It also includes the indirect effects of the expansion in the budget deficit in FY 2023. The official deficit didn’t expand much, but that’s because President Biden announced a plan to forgive student loans in 2022 and then the Supreme Court struck it down in 2023. Neither of these affected the government’s cash flow but they did change official government accounting. Taking them out means the deficit expanded to 7.5% of GDP in FY 2023 from 3.9% in FY 2022.
In addition, and as we explained recently (MMO, April 8), if monetary policy were really tight, inflation would be persistently declining. But CPI prices were up 3.0% in the year ending in June 2023 and are now up 3.5% in the past year. This suggests residual effects of past monetary looseness are still boosting the economy.
We estimate that Real GDP expanded at a 2.6% annual rate in the first quarter, mostly accounted for by an increase in consumer spending.
Consumption: “Real” (inflation-adjusted) retail sales outside the auto sector declined at a 3.0% annual rate in Q1 while auto sales declined at an 8.7% rate. However, it looks like real services, which makes up most of consumer spending, soared at a 4.7% pace. That’s the fastest pace for service growth since the re-opening from COVID in 2020-21. Excluding that re-opening, when all the data were whacky, it's the fastest pace for service growth since the peak of the Internet Bubble in 2000. Putting it all together, we estimate that real consumer spending on goods and services, combined, increased at a 3.1% rate, adding 2.1 points to the real GDP growth rate (3.1 times the consumption share of GDP, which is 68%, equals 2.1).
Business Investment: We estimate a 2.4% growth rate for business investment, with gains in intellectual property leading the way, while commercial construction declined. A 2.4% growth rate would add 0.3 points to real GDP growth. (2.4 times the 14% business investment share of GDP equals 0.3).
Home Building: Residential construction is showing some resilience in spite of some lingering pain from higher mortgage rates. Home building looks like it grew at a 5.0% rate, which would add 0.2 points to real GDP growth. (5.0 times the 4% residential construction share of GDP equals 0.2).
Government: Only direct government purchases of goods and services (not transfer payments) count when calculating GDP. We estimate these purchases were up at a 2.3% rate in Q1, which would add 0.4 points to the GDP growth rate (2.3 times the 17% government purchase share of GDP equals 0.4).
Trade: Looks like the trade deficit expanded in Q1, as exports grew but imports grew even faster. In government accounting, a larger trade deficit means slower growth, even if exports and imports both grew. We’re projecting net exports will subtract 0.5 points from real GDP growth.
Inventories: Inventory accumulation looks like it picked up in Q1, but only slightly versus Q4, translating into what we estimate will be a 0.1 point addition to the growth rate of real GDP.
Add it all up, and we get a 2.6% annual real GDP growth rate for the first quarter. Solid for now, but we expect slower growth later this year as the temporary effects of government deficit spe
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Elections Matter
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 04/15/2024
Many, us included, see parallels between today’s big issues and those of the 1960s and 1970s. Mistakes in both geopolitical and fiscal policies compound overtime, often leading to more mistakes. After Vietnam ended badly, US weakness likely encouraged terrorism. The 1972 Munich Massacre of Israel Olympic Athletes, Entebbe in 1976, and finally US hostages held in Iran from 1979 to 1981.
At the same time both fiscal and monetary policy became unhinged. The result was stagflation, with inflation hitting and unemployment approaching double digits. We don’t have room for a complete historical explanation, but Presidents Johnson, Nixon, Ford, and Carter each made mistakes in either foreign or fiscal policy that led to these problems.
Then, Ronald Reagan was elected, and while his opponents claimed he would cause nuclear war, the exact opposite happened. Stagflation was ended, the Berlin wall fell, and the world entered a mostly peaceful era. Elections matter.
With Iran attacking Israel over the weekend, and unsustainable budget deficits eroding the US fiscal situation, we are reminded of the 1970s. In fact, there were two decisions made under President Carter almost fifty years ago that have helped create both of these issues.
We focus on policy, not personality. We are not attacking President Carter himself. He appears to be a very good and decent man. His great charitable work after leaving the presidency speaks for itself and sets a great standard for other former officeholders. In addition, President Carter bucked his party and deregulated both the trucking and airline industries.
However, Carter also made some serious blunders. On the geopolitical front, it was Carter who decided (1) not to back the Shah of Iran in 1978 and after that (2) not to pursue regime change in Iran after the seizure of American hostages and a coup d’état against the duly-elected Iranian President Banisadr (who had to flee for his life back to France).
Now the Islamic Republic of Iran effectively controls Syria, much of Iraq, Lebanon, Gaza, some of Yemen, and in the meantime is aligning with rivals of the US, such as China and Russia. With every passing decade it has become more difficult to dislodge the regime in Iran and now, in the absence of a change in the near future, it may only be a matter of time before Iran is able to acquire a nuclear weapon.
On the fiscal side, President Carter also championed an arcane but incredibly important change to Social Security enacted in 1977. This change virtually guaranteed the long-term insolvency of the old-age pension portion of the Social Security system unless future policymakers agree to some combination of tax hikes or benefit cuts.
Before these changes were made, Social Security payments were adjusted by inflation, what we call the cost-of-living adjustment (COLA). Until the mid-1970s, Congress had to vote to make this adjustment and politicians took credit every time they did. But, as inflation became more of a problem, the annual COLA was tied directly to the Consumer Price Index.
The COLA adjustment automatically increased both current and future benefits. But Carter added a wrinkle. Current recipients would receive the COLA adjustment, but future benefits would rise by both the COLA plus an estimate of real wage gains. At first this made little difference, but through the magic of compounding, this adjustment for real wages adds up and the current trajectory of payments is unsustainable.
Carter and other policymakers were warned about this problem at the time, but didn’t pay it heed. No wonder people see similarities between today and the 1970s. Current policies and past policies are colliding to create the very same problems. As November approaches, voters would do well to remember this history. Their decisions are not just about the next few years, but will resonate for decades to come. Solid US leadership can change the entire world.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Is the Fed Tight, or Not?
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 04/08/2024
In the waning seconds of one of the most watched women’s college basketball games ever, a foul was called. The University of Connecticut was playing the University of Iowa in the semi-finals of the women’s NCAA championship tournament. Officials called a UConn player for an “illegal screen” on an Iowa defender, which helped Iowa win the game. This happened Friday night, and on X (formerly Twitter) the debate about this call still rages.
In spite of the debate, that game is over. On Sunday, Iowa lost to South Carolina in the finals and the world moves on. Meanwhile, in the realm of economics, a different debate rages. Is Federal Reserve policy tight, or not?
Ultimately, there is an ironclad two-part test to determine if monetary policy is tight. First, has the economy weakened to below trend growth? More clearly, is GDP falling, or unemployment rising? And second, has inflation persistently declined. If those things haven’t happened, it's hard to argue monetary policy has been tight.
At present, we are tracking Real GDP growth at about a 2.0% annual rate in the first quarter, which is close to the long-term average. This follows all of 2023, and the last two quarters of 2022, where quarterly real economic growth was faster than 2.0% each and every quarter. At the same time, unemployment remains below 4.0%. In other words, we haven’t yet had an economic slump consistent with tight money.
For inflation – after dropping from what appears to be a supply-chain induced spike of about 9.0% in mid-2022 – CPI inflation fell to 3.1% in mid-2023. But lately, CPI inflation has stopped its decline. We estimate that consumer prices rose 0.3% in March and the Cleveland Fed’s CPI Nowcast currently projects 0.3% for April, as well. If so, the overall CPI will be up 3.3% in April versus the year prior.
So, both real growth and inflation show little impact from Fed tightening, in spite of many of the traditional measures of monetary policy signaling tightness. For example, the M2 measure of the money supply peaked in April 2022 and is down 4.3% since. We haven’t had a drop like that since the early 1930s during the Great Depression. Yes, the monetary base is up 10.7% in the past year, but unless that base money is converted into M2, it likely has little impact. Following the 2008-09 financial crisis, quantitative easing didn’t turn into M2 and inflation remained tame…but during COVID, QE did cause M2 to spike, and inflation jumped.
Meanwhile the slope of the yield curve between the target federal funds rate and the 10-year Treasury yield has been inverted since late 2022, a typical sign of tight money. And while not as clear cut, the federal funds rate has been 2.0 percentage points, or more, above inflation in the past six months. While we would say these rates are roughly neutral, not really helping or hurting growth, this is a huge change from the 2009-2021 period, when rates were held well below inflation.
Think of it this way: imagine you’re trying to freeze water, at sea level. A thermometer shows the temperature is 25⁰F and the water isn’t freezing. Does this mean the laws of chemistry and physics have been repealed? Of course not! Any sensible person would think that the thermometer must be broken, or maybe the liquid you’re trying to freeze isn’t water after all.
Which brings us to one signal of monetary tightness that hasn’t been triggered yet. History suggests that interest rates should be roughly equal to “nominal” GDP growth (real GDP growth plus inflation) – a cousin to what is called the “Taylor Rule.” Nominal GDP is up 5.9% in the past year and a 6.5% annual rate in the past two years. Yet, the federal funds rate is just 5.4%. That’s not tight money! Maybe that’s the measure of tightness we should have been following all along.
In other words, maybe one of the reasons we haven’t yet experienced economic turbulence is that monetary policy hasn’t been as tight as most investors thought. If so, it could take much longer to bring inflation down to 2.0% than the Fed expects, which means short-term rates could stay much higher for much longer.
In turn, that would mean more economic pain ahead than most investors currently expect. Some calls are hard to make no matter how much time is left in the game.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
The Fed Audit
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 04/01/2024
Several years ago some politicians started demanding that the Federal Reserve get audited. We think the idea has some merits but also some drawbacks, as well.
One problem with the Fed is that it doesn’t have a hard limit on its own spending. For example, let’s say the Fed wanted to hire a bunch of extra staff to write papers on climate change, income inequality, gun control, or other “political hot button” issues of the day that don’t really have a direct relationship with monetary policy or the Fed’s mission. Our understanding is that there’s nothing to stop the Fed from doing so, as long as it claims some relationship to monetary policy, no matter how tenuous.
And even if the appointed leaders at the Federal Reserve Board object, there are still twelve regional reserve banks around the country that could do so, and their leaders are not appointed by the president or confirmed by the Senate. In fact, the Chicago Federal Reserve Bank already has staff dedicated to researching topics that impact the “greater good” and “community development.”
Depending on the party in power, auditing the Fed could lead Congress to mandate more or less of these endeavors, and at the same time put more political pressure on the Fed to tilt monetary policy in a way that politicians see as favorable toward themselves, which would mean less Fed independence. History shows clearly that less central bank independence correlates closely with higher inflation and less currency stability.
What we would suggest is a law that limits the Fed to activities that directly, not indirectly, impact monetary policy. Those areas can be measured with an accounting audit by an outside firm, which the Fed already does. Last week the Fed released its audited financial statements for 2023 and they were…. interesting.
Most prominently, the Fed lost $114 billion last year. This is the first time the Fed has ever run an annual loss and the loss is a direct consequence of the Financial Panic of 2008 when the Fed started paying banks to hold reserves.
Prior to that change, the Fed did not pay banks to hold reserves, meanwhile earning interest on the securities in its portfolio (mostly Treasury bills). But after the change, when the Fed was holding rates close to zero, it still ran surpluses. When the Fed held rates low, it contributed an average of more than $75 billion annually to government revenue.
But holding rates too low creates distortions in financial markets and rates had to go higher. In order to “normalize” rates, the Fed now pays banks 5.4% on their excess reserves. The result is that the Fed paid private banks $281 billion in 2023.
But the Fed earns less than that on its bond portfolio. To repeat, it lost $114 billion in 2023 and has a total accumulated deficit of $133.3 billion since 2022. The Fed calls these accumulated losses a “deferred asset” because it expects to return to profitability in the future.
These kinds of losses should invite political oversight. Does the Fed just borrow more from the Treasury (the taxpayer) to meet payroll? If so, there is already a reason to doubt its independence from the political side of government. Rather than audit the Fed, which is already done, laws which require more transparency and a more focused mission, would be productive. The Fed has become too political. That should change.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Welcome to State-Run Capitalism
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 03/25/2024
We’ve mentioned this before, but it bears repeating. It seems that investors pay as close attention to what the government is doing, as they do to actual business news. We don’t think investors are wrong to do this, but it’s only because government has become so big.
The US has moved from a simple Keynesian-type model to what we call “State-Run Capitalism.” When the economy turns soft, a typical “Keynesian” (demand-side) response would be to boost the budget deficit or print more money.
Now, the government is running permanent, and very large, deficits and using its budget to fund semiconductors, EVs, solar and wind energy generation, as well as redistributing more money to immigrants and students who are in debt. This all smells and looks like central planning…or State-Run Capitalism.
At the same time, because the Fed is now using an abundant reserve monetary policy, it has taken the financial system out of the process of determining short-term interest rates. Banks no longer need to trade excess reserves, so the federal funds rate has no real market. The Fed just makes that rate up.
So, here we sit in 2024, and a Wall Street Journal economics reporter, Greg Ip, just wrote a piece titled “The Economy is Great…”. We don’t think that’s really true, but real GDP did grow more than 3% last year and job growth has been robust.
A typical Keynesian response to this, the one most people were taught in economics class, would be for the government to run a surplus, or at least substantially shrink the deficit, and the Fed to be at least slightly worried about over-heating the economy.
Instead, Congress just pushed through a $1.2 trillion spending bill with a deficit that will approach $1.6 trillion, and the Fed announced that it was likely to cut rates three times in 2024.
What the heck? Why? Especially with inflation reports so far in 2024 coming in hot. The Cleveland Fed median price index is up 4.6% from 12 months ago, “supercore” CPI is up 4.3% over 12 months, and nearly 7% annualized over the past three months. With inflation this high, and the economy “great,” no traditional Keynesian would support these policies.
We don’t blame investors for reading the tea leaves and realizing that all this stimulus is probably good for the markets in the short run. Lower rates mean more growth and higher price-earnings ratios. The market seemingly (and perhaps correctly) has decided that the Fed, and the Federal Government, can manage the economy to keep stocks up.
But all of this will come with a price. No centrally-managed economy has been permanently made to go only one way. It can look good for a time, but eventually the sheer size of the government and the mishandling of monetary policy catches up. On a smaller scale, the US tried this in the 1970s, and the result was stagflation. Russia, Venezuela, and a host of other countries have all failed.
But it doesn’t happen overnight. More importantly, because the Fed has separated the growth of the money supply and the level of interest rates, rate cuts may not mean what many people think they do. Yes, rates may come down this year, but the money supply has contracted in the past year. A contraction in the money supply is never a good sign.
We still expect a recession this year. The US will have an irresponsible deficit, but it will be slightly less irresponsible than it was last year. Add in a decline of M2, and the morphine pumped into the system over the past few years has worn off.
If the Fed is cutting rates because it is an election year, and if the government is spending money in an effort to entice some voters to see it as personally beneficial to vote for big government, it’s a recipe for lousy economic outcomes.
When the government pushes money in directions that are politically beneficial, they are often not efficient in a true economic sense. This means less growth and more inflation. We are very worried about stagflation in the years ahead.
Between now, and whenever that is, the market may completely ignore it. And, investors will think the government has found a recipe for permanent prosperity. But after thousands of years of trying, and never making it happen, we bet against even this new version of State-Run Capitalism.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
Focused on the Fed
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 03/18/2024
The Fed meets this week, which means investors and analysts will be sifting through Wednesday’s FOMC statement, updated economic projections, the “dot plots,” and Powell’s press conference searching for any signal – real or imagined – about what our central bank will do next. In particular, the market is on tenterhooks about when rate cuts will start, how fast those rate cuts will come, or if the Fed will simply hit the “pause” button on the prospect of rate cuts until deep into 2024.
We think this obsession with the Federal Reserve is unhealthy. Instead of an obsession with slight policy shifts out of Washington, DC, we think investors need to be focused on more important matters, like the process of innovation, entrepreneurial risk-taking, and corporate profits. In the end, it’s these factors that will drive stock market valuations the most, not the vagaries of the short-term interest rate target by the mandarins of money.
Things have changed a great deal since the last Fed meeting on January 31. Back then, the futures market expected about six rate cuts of 25 basis points each this year, with the first cut coming in March. As of Friday’s close, the market was expecting only three rate cuts this year, with the first one coming in either June or July.
No wonder the shift in rate expectations given recent reports on inflation. The two CPI reports since then show consumer prices up at a 4.6% annual rate in the first two months this year. And no, this was not food and energy; “core” prices, which exclude those two volatile categories were also up at a 4.6% annual rate so far this year.
Even worse for the Fed is that the newly made-up slice of the CPI that the Fed and others call the “Super Core” measure of inflation, which includes services only (no goods) but also excludes food, energy, and housing rents, rose 0.8% in January and 0.5% in February. That’s a growth rate of 8.2% annualized so far this year. Notice how you used to hear a lot about this measure a year or so ago when it was indicating lower inflation and now few dare speak its name when it shows inflation re-accelerating! Meanwhile, overall producer prices are up 5.4% so far this year and “core” producer prices are up at a 4.5% annual rate.
None of these figures are remotely close to the 2.0% inflation goal the Fed claims it’s still targeting.
The problem for the Fed is that there are signs that the economy may be slowing. Although retail sales rose 0.6% in February, after factoring in downward revisions to prior months, retail sales rose a tepid 0.1%. “Core” sales, which exclude volatile categories such as autos, building materials, and gas stations — and is a crucial measure for estimating GDP — increased by 0.1% in February, but was revised significantly lower for previous months, down 0.5%. If unchanged in March these sales will be down at a 0.7% annual rate in Q1 versus Q4, which would be the first quarterly decline since the COVID lockdowns.
Industrial production rose a tepid 0.1% in February but that follows declines of 0.3% and 0.5% in December and January, respectively. We like to follow manufacturing output excluding the auto sector (which is volatile) and that is down 0.9% from a year ago. Not a good sign.
As always, we will be watching the press conference following Wednesday’s meeting for any mention of the Fed looking more closely at the money supply, but we won’t get our hopes up. The M2 measure of money is down 2.0% in the past year, which would not be good for the economy if these figures are accurate and if they continue.
Another key issue is whether the Fed will publicly abandon it’s 2.0% target to make it easier on themselves to achieve their goal. We think that will happen eventually, but that’s several years from now, not soon. The Fed likely thinks it would lose credibility if it announced a higher target for inflation, and could send long-term interest rates spiraling upward; that’s not a risk the Fed would take, particularly in an election year.
Our advice to investors: listen to and watch the Fed but don’t obsess about it. The changes in monetary policy from meeting to meeting don’t matter nearly as much as the productive capacity of the American people.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Is the Job Market Really That Strong?
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 03/11/2024
If you only look at the headlines about the monthly payroll report, the job market has looked surprisingly strong in recent months. Nonfarm payrolls rose 275,000 in February, beating the consensus expected 200,000 as well as the average of 229,000 per month in the past year.
But a deeper look at the data makes it look about as fishy as week-old sushi. Now, we’re not alleging some sort of “Deep State” conspiracy, we’ll leave that to others. But reviewing the report in its entirety show the job market is not nearly as strong as the top line payroll readings suggest.
For example, look at the revisions. Payrolls in December and January were revised down by a total of 167,000 (the largest monthly downgrade for any non-shutdown months since late 2008), meaning February was just 108,000 above the original January level. And it was even worse in the private sector, where payroll gains were a paltry 19,000 for the month after netting out revisions for prior months.
What’s odd about these downward revisions is that they seem to happen pretty darn often of late. In 2023, for example, the regular two-month revision process reduced the initial monthly report by 30,000, on average. That ain’t chump change. In the past few decades, negative revisions like this have normally been associated with recessions or the immediate aftermath of recessions.
It's also important to follow civilian employment, an alternative measure of jobs that includes small-business start-ups. On a monthly basis, these figures are volatile, and are affected by estimates of the size of the total population, so take them with a grain of salt. But the trend is important and isn’t anywhere as strong as payrolls. While payrolls are up 2.7 million in the past year, civilian employment is up 0.7 million and the unemployment rate has risen to 3.9%. Moreover, the gain in civilian employment in the past year has all come in part-time work, with a slight loss for full-time jobs.
There may be solid technical reasons for this large gap. The figures are generated by two different surveys (one for employers, the other for households), and maybe the massive influx in immigrants, even if largely illegal, is finding its way into payroll expansion (perhaps with illegal hiring or false documents) in a way not being picked up by the civilian survey. We’re guessing many recent immigrants are not eager to answer surveys sent by the Labor Department.
Notably, among those who do answer the survey, civilian employment among the native-born population is down around 900,000 from a year ago – the first drop since the onset of COVID – versus an increase of about 1.5 million among the foreign-born.
Only time will tell the true underlying health of the labor market. There is no clear signal we’re in a recession, but the patient isn’t looking well. What is clear, is that economic risks abound, and a soft landing is far from guaranteed.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Is a Debt Spiral Already Here
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 03/04/2024
Washington DC continues to spend much more than it gets in revenue. In the Calendar Year of 2023, the federal government spent $6.3 trillion, but only collected $4.5 trillion in taxes. This $1.8 trillion gap drove the national debt to $34 trillion in December 2023. And it is only going higher.
One problem with these budget numbers is that government accountants, rightly or wrongly, lowered spending in 2023 by about $300 billion after the Supreme Court struck down a large part of President Biden’s proposal to forgive student loans. That legal decision didn’t change the government’s cash flow last year in any significant way, but it did let the Department of Education “write up” the value of its loan portfolio by about $300 billion. This, they counted as “negative spending,” which then reduced the official budget deficit. So, while the reported deficit in 2023 was $1.8 trillion, the Treasury needed to borrow more than $2 trillion to make ends meet.
The high levels of borrowing are causing some investors to fear some sort of imminent and unprecedented snowballing of federal debt. Continual borrowing will lead to skyrocketing interest rates (and higher interest payments), which will lead to severe problems in the financial system.
In particular, they note that since June 2023, when the debt ceiling was suspended, total Treasury debt outstanding has gone up by nearly $3 trillion. That includes a total of $874 billion in the second quarter of 2023, $835 billion in the third quarter, and $834 billion in the fourth quarter. Other than 2020-21, during COVID lockdowns, the debt has never gone up this rapidly, not even in 2008-2009.
But it’s important to remember that the debt does not go up at a steady rate during the course of the year. In 2023, during March and April, the federal government received a surge in tax receipts, which temporarily reduced the amount of debt outstanding. We think this will happen again this year, particularly because the S&P 500 went up 24% last year and the federal government is therefore likely to reap lots of non-withheld revenue.
As a result, the Congressional Budget Office estimates that individual income tax payments will be up 13.4% this year and the budget deficit will come in at roughly $1.5 trillion versus $1.7 trillion in Fiscal Year 2023. On that score, we are not as optimistic. Even as we write this, Congress is debating foreign aid measures that, whether you like the underlying policy or not, will, by themselves, boost the deficit.
And while the cost of servicing the debt is going up, the interest measure that matters is the net interest on the debt relative to GDP. In other words, what matters is how much of our national income is needed to service the debt. That measure, while climbing and a problem, is still below the average of roughly 3% of GDP it was back in the 1980s-90s.
However, because we think interest rates will remain higher than government accountants think, the carrying cost of our debt will move higher.
The bottom line is that federal government spending is way too high and most politicians do not seem to care. There are those who look at these numbers and assume some kind of imminent crisis, when what we see is a slow, but unavoidable decay in our underlying potential to grow. New technologies are raising productivity, but a huge government acts like a ball and chain on those benefits.
For now, the markets are ignoring this, and assume a soft landing with lower interest rates. But the more economic growth is undermined, the less likely this outcome.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Watching the Fed
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 02/26/2024
Every day this week, investors will get data on the economy. New home sales today, then capital investment, GDP, consumer incomes and spending, manufacturing, and auto sales are on the list. All of this will feed into the outlook for what the Federal Reserve might do with interest rates this year.
Pretty much everyone expects the Fed to cut rates this year, but expectations have changed. A month ago, the futures market was pricing in five or six twenty-five basis point (bps) rate cuts in 2024 (125 - 150 bps in total); now the market is pricing in three or four (75 - 100 bps total). Two relatively strong employment reports and an upside surprise with Q4 GDP data caused some rethinking, but this could be reversed just as easily.
While all these data points matter, we will be watching another release very closely, as well, one that few investors pay attention to and the Fed itself either doesn’t care about or is doing a great job pretending it doesn’t care about: tomorrow afternoon’s report on the growth of the money supply, or lack thereof, the M2 measure of money, in particular.
That measure of money, in spite of QE, did not soar during the Great Recession and Financial Crisis of 2008-09, and therefore did not cause inflation. The main reason is that though the Fed did trillions in QE, through heavy-handed regulation, banks were forced to boost reserves.
But 2020-21 was different. Banks were paid to push the money into the economy (remember PPP loans?) and M2 skyrocketed 40.7%. This led to the surge in inflation that followed in 2021-22. Since then, M2 has actually declined 3.2% in 2022-23, taking the steam out of inflation, but so far hasn’t affected economic growth.
But in the last two months of 2023, M2 started growing at a moderate pace again, up at a 4.1% annualized rate. If the Fed keeps it up, not just for one month but as a trend, that would be good news and might even reduce the risk of a recession later this year.
While we watch M2, others have been eyeing the relationship between long and short interest rates. In October 2022, the 3-month Treasury yield rose above the 10-year yield, and has stayed there. This is called an “inverted yield curve” and historically signals that the Fed is tight and a recession is often on the way.
But in an “abundant reserve” monetary policy, higher short term interest rates no longer signal “tight” reserves. In fact, with reserves so abundant, the Federal Funds Rate is no longer determined in a market, but is actually set at the whim of the Fed. Technically, this is price fixing.
So, the yield curve doesn’t mean what it once did. Longer term bond yields now are hugely affected by what investors think the Fed might do with rates, rather than how those rates reflect underlying economic trends. The Fed has convinced itself and the markets, that it can move rates up and down with the economic data perfectly, but this is hubris. The Fed has held interest rates below inflation roughly 80% of the time since 2009, leading to distortions in markets and the banking system.
Having said that, with short-term rates no longer excessively low, and the money supply down in the past 18 months, we believe the economy is starting to falter.
Retail sales have declined in three of the past four months. Manufacturing production, excluding the auto sector has declined four months in a row. Meanwhile, home building got hammered, with both housing starts (-14.8%) and completions (-8.1%) dropping sharply while new home sales are down 5.3% in the past four months.
We advise watching the path of M2 to tell how much additional faltering it will do in the year ahead.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
January Stagflation
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 02/20/2024
A key economic mistake people make is thinking growth leads inflation. One reason they do that is because inflation is a monetary phenomenon. When money is too easy, first growth rises, and then inflation rises with a longer lag due to excess dollars in the system. This process reverses when money is tight, first growth slows, then with a longer lag inflation does too.
That makes 2023 an anomaly. The economy has remained resilient, but year-over-year consumer price inflation has moderated from a peak of 9.1% in mid-2022 to 3.4% in December 2023.
One theory is that the high inflation was all due to economic bottlenecks and supply constraints during COVID, so the end of lockdowns and the process of getting back to normal has expanded supply, leading to both faster growth and lower inflation. There’s no doubt that the imposition of lockdowns and then the re-opening from those lockdowns had “supply-side” effects – first negative, then positive – and are consistent with this explanation.
But it’s a flawed explanation. If supply constraints and their loosening were the key drivers of inflation, we would expect pandemic driven inflation to be followed by outright deflation as the economy reopened and returned to normal. That clearly hasn’t happened, and inflation remains stubbornly high.
Instead, we believe monetary policy played the key role. The M2 measure of the money supply soared 41% in 2020-21, the fastest since World War II. This measure of the money supply then declined 3.2% in 2022-23, the largest two-year drop since the Great Depression. These swings in M2, the relative sizes of the swings (larger up than down), and the long lags between shifts in M2 and inflation do a much better job explaining the inflation pattern of the past few years.
The problem with this theory of “monetary dominance” is that classical liberals like Milton Friedman and the Austrians would expect economic growth to take a hit before inflation were brought back down to normal. And yet Real GDP grew 3.1% in 2023, which is above the 2.0% long-term trend.
So what gives? Our belief is that the US injected so much money, so rapidly, that the economy couldn’t absorb it instantaneously. So, now, what we have seen is that even though M2 has declined, we still haven’t absorbed all the money that was added. Some call it excess savings, we call it excess M2.
But the US has finally absorbed the excess money, and fiscal stimulus is waning as well. And guess what? Recent reports for January show an economy that may be weakening faster than most investors realize. Retail sales fell 0.8% for the month and have declined in three of the past four months. Manufacturing production fell 0.5% in January and manufacturing excluding the auto sector (the auto sector is volatile) has declined four months in a row.
Meanwhile, home building got hammered in January, with both housing starts (-14.8%) and completions (-8.1%) dropping sharply. It’s possible that colder than normal January temperatures were a factor, as well as unusually high precipitation, but the drop in starts was in every major region of the country, the drop in completions happened in most regions (except for the West), and while weather was bad, quantitative measures of national heating requirements were not unusually high in January.
We’ve had bad weather before – and apocalyptic weather reports are clearly clickbait for some in the news media – but housing starts in January were the second lowest for any month since mid-2020, during the onset of COVID when lockdowns still prevailed in much of the country. In other words, we see these data potentially signaling broader economic weakness, consistent with the drop in retail sales and decline in manufacturing production in January.
And yet inflation was also a problem in January, with both consumer and producer prices rising 0.3%, faster than the consensus expected and inconsistent with the Federal Reserve’s 2.0% target inflation.
A weakening US economy with inflation remaining (temporarily) stubbornly high would be consistent with the monetary dominance story of inflation’s rise and fall and would also be a problem for the stock market. Using our Capitalized Profits Model, with a 10-year Treasury yield at about 4.25%, economy-wide corporate profits would need to rise 30%+ to justify an S&P 500 at 5,000. But there’s no way profits (ex-Fed), which are already high relative to GDP would surge that much higher in a soft economy. The current consensus puts profit growth at roughly 10% this year.
Time will tell if the weakness in January becomes more widespread. On the surface, the job market still looks fine, with payrolls up more than 300,000 in both December and January. But the labor market can be a lagging indicator.
Unprecedented policies during COVID have created noise in the data. But underneath it all, we still believe Milton Friedman had it right. A decline in money will lead to recession, and then a decline in inflation.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
CBO’s Rosy Scenario
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 02/12/2024
Last week the Congressional Budget Office set out new projections for budget deficits and debt in the decade ahead, and they weren’t quite as bad as they looked last year. The CBO now projects a deficit of 6.4% of GDP in 2033 versus a prior forecast of 7.3%. Total accumulated debt by 2033 is now forecasted to be 114% of GDP versus 119%. None of this is “good” news – deficits and debt would still be too high – but it is “less bad.”
The problem is that the CBO’s assumptions are way too rosy. In particular, it assumes the end of many of the tax cuts enacted in 2017 without any negative effects on the economy. Fat chance! More likely, growth would slow and revenue would come in low, meaning bigger budget deficits.
But it will also be tough to hit the CBO’s revenue projections if we keep the 2017 tax cuts fully in place. The CBO is forecasting “real” (inflation-adjusted) economic growth of about 2.0% per year, on average for the decade ahead, the same growth we’ve experienced since the end of 2000 (before the 2001 recession) and since the end of 2019 (the business cycle peak prior to COVID). If we tax that economy at lower rates than CBO projects it’ll yield less revenue than CBO projects, as well.
The bottom line is that no matter what candidates say this year on the campaign trails in their races for the White House, Senate, and House, both parties are going to have to find ways to limit deficits in the years ahead. If we get a GOP sweep – which we believe would result in a continuation of the 2017 tax cuts (and on which we put 35% odds, up from 30% last November) – we expect measures to fight the deficit to include curbs on “green energy” subsidies, more tariffs, and Medicaid reform.
If the Democrats sweep (20% odds) then we think a wide range of tax hikes will be on the table, including raising the top income tax rate (now 37%) back to 39.6%, raising the top long-term capital gains and dividends tax rates (now 20%) to at least 24%, reducing estate tax exemptions, raising the standard corporate tax rate (now 21%) to 35%, and possibly introducing a carbon tax, which the Clinton Administration very briefly considered in 1993. Back then, both Senators from Nebraska were Democrats, which helped keep President Clinton away from a carbon tax; now the Democrats get very little support from energy-intensive states.
But in a world where the current House majority is razor thin and some election maps are still being redrawn, it shouldn’t shock anyone if we end up with “mixed government” in 2025-26, with the GOP holding at least one of the White House, Senate, and House, and the Democrats holding at least one, as well. We’d put the odds on that at about 40-45%, at present.
With mixed government, expect some brutal political fights. Does anyone think a Speaker Hakeem Jeffries would simply rollover for a Republican president and accept a full extension of the 2017 tax cuts, or anything close? Why wouldn’t a Republican president test the Supreme Court by “impounding” (refusing to spend) money appropriated by Congress, which hasn’t happened since the early 1970s? The bottom line is that for all the fighting, mixed government scenarios would likely generate no entitlement reforms and little deficit reduction, leaving plenty of time for the bond vigilantes to sharpen their knives.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Labor Market Not Adding Up
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 02/05/2024
On the surface, there’s much to like about the job market. But when you get into the details, it’s not quite as strong and some things don’t add up. Here’s what to like.
The establishment survey answered by a sample of businesses showed that nonfarm payrolls increased 353,000 in January, easily beating the consensus expected 185,000, the largest gain in a year, and coming in higher than the forecast from every economics group (that filed a forecast with Bloomberg). Meanwhile, payroll gains were revised up by 126,000 for November and December, bringing the net gain, including revisions, to 479,000. In the past year, payrolls are up 2.9 million or 244,000 per month.
We like to follow payrolls excluding government (because it's not the private sector), education & health (because it rises for structural and demographic reasons, and usually doesn’t decline even in recession years), and leisure & hospitality (which is still recovering from COVID Lockdowns). That “core” measure of payrolls rose 194,000 in January, which is the best month since mid-2022.
That same payroll survey showed that average hourly earnings – cash earnings, excluding irregular bonuses/commissions and fringe benefits – rose 0.6% in January and are up 4.5% versus a year ago. The Federal Reserve might not like that – the odds implied by the futures market that the Fed will cut rates by the end of the May 1 meeting went down substantially – but it is good news for workers and means wage growth per hour is out-stripping inflation.
Meanwhile, the survey that samples US households showed that the unemployment rate remained at 3.7%.
But here are the details and figures that make us wary about just accepting all the good news at face value.
First, the same payroll survey showing strong job growth is showing a concerning drop in the number of hours per worker. Workers in the private sector worked an average of 34.6 hours per week in January 2023; this January they were down to 34.1. Average weekly hours haven’t been this low since March 2020, with the onset of COVID.
As a result, even though total jobs are up 1.9% in the past year, total hours worked are up only 0.3%. To put this in perspective, a 0.3% increase in private-sector jobs in the past year would have meant private payroll gains of 33,000 per month, not the 194,000 per month we experienced. (A 0.3% gain in jobs is what would have happened if businesses had hired workers to fill the extra hours they needed but kept the number of hours per worker the same.)
Second, the household survey measure of employment hasn’t been rising nearly as fast as payrolls, which is something that has happened in the past prior to recessions. As we noted earlier, nonfarm payrolls (which includes government workers) are up 244,000 per month in the past year. But the household survey (smoothed for recent population adjustments) is up only 101,000 per month in the past year. That’s a very large gap by historic standards.
Another issue is the oddity of having payroll growth of 244,000 per month in the past year while the unemployment rate has been so low. Since February 2001, right before the 2001 recession, payrolls have grown at an average pace of 91,000 per month. Since February 2020, right before COVID, payrolls have grown at an average pace of 115,000 per month. Those longer-term averages make sense given a growing population in the context of an aging workforce.
But how then can we have payroll growth so much faster in the past year, particularly when the unemployment rate is already so low? Usually job growth gets slower when the jobless rate is near bottom.
One theory can explain this, however: that the US economy has been temporarily boosted by having the government run a larger budget deficit, including the effects of the CHIPS Act, infrastructure bill, and the Inflation Reduction Act. But that artificial boost should soon come to an end. And when it does job growth should slow sharply, as well.
A strong job market is a good thing, but it doesn’t mean a recession can’t start soon. Payrolls are up 1.9% in the past year. But they were up the same in the year ending in January 1990 and a recession started mid-year. They were up 1.3% in the year ending January 2001 and a recession started in Spring 2001. The flu starts when you’re feeling good and it’s normal for a recession, like the flu, to come when the economy looks fine.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
A Stock Market Conundrum
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 01/29/2024
The economy is still growing. Real GDP rose at a solid 3.3% annual rate in the fourth quarter, and consumer spending was strong in December meaning the first quarter is off to a good start. New home sales came in above expectations and initial jobless claims remain low, although orders for durable goods came in low due to weak demand for aircraft.
All eyes are now on Friday’s jobs report, which we expect to show a gain of about 170,000 while the unemployment rate holds steady. But the strength in employment seems fragile. If we exclude job gains in government, health & education (which are largely funded by government), and leisure & hospitality (still recovering from lockdowns), job growth looks exceptionally weak. In the last seven months of 2023, payrolls excluding those categories rose only 3,000 per month, the kind of weakness we might expect before a recession. In other words, much of recent growth is fueled by government deficits.
Meanwhile the stock market continues to rally, with the S&P 500 closing at a new record high last Thursday. That’s great, but we aren’t exactly sure what the market sees.
If the economy remains healthy and keeps growing, it’s very hard to imagine the Federal Reserve cutting short-term interest rates by the 125-150 basis points the markets appear to expect. In turn, less rate cutting than the market expects should be a headwind for equities in 2024.
What would get the Fed to cut rates by 125-150 bps? Either a sharp drop in inflation or a decline in economic growth. While lower inflation is good, can a sharp drop happen without a weak economy? Either way, we don’t think the stock market would like that outcome because they would likely signal lower corporate profits.
This is all consistent with our Capitalized Profits Model, which still says stocks are overvalued. That model uses economy-wide profits from the GDP accounts (excluding profits or losses by the Fed) and discounts them by the 10-year Treasury yield. Using the level of profits in the third quarter (we won’t get Q4 numbers for profits until the end of March) and a 10-year yield of 4% (which was its yield before rate cut expectations started to evaporate), suggests the S&P 500 would be fairly valued at about 3,900, well below recent highs.
What would it take to suggest that recent stock prices are appropriate? A 10-year yield of 3.2% would do it. So would a 30% increase in profits. But a 3.2% yield would probably be accompanied by lower profits and a 30% surge in profits would likely be accompanied by a much higher 10-year yield, so fair value is even further away than it seems.
The only way out of this conundrum is if Artificial Intelligence and other new and rapidly advancing technologies provide a miraculous boost to productivity. This could keep growth strong, or even accelerate it, while bringing inflation down. In other words, profits up and interest rates down.
While this could happen, it would take a miracle. And while expecting miracles worked for San Francisco fans, we still think investors should remain cautious. The monetary and fiscal stimulus that made COVID lockdowns seem like a bump in the economic road are wearing off.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Slower Growth in Q4, But No Recession
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 01/22/2024
The economy slowed substantially in the last quarter of 2023 from the rapid pace of the third quarter, but, as we explain below, still expanded at a moderate rate. Some will take this week’s Real GDP report to confirm their prior view the recession is simply not in the cards for the US economy, but we still think a recession is more likely than not.
Why do we still think a recession is coming? Because monetary policy is tight whether you like to use the yield curve, the “real” (inflation-adjusted) federal fuds rate, or the M2 measure of money to assess the stance of policy from the Federal Reserve.
Why hasn’t a recession happened yet? Because monetary policy works with long and variable lags and a surge in the budget deficit in 2023 temporarily postponed the economic day of reckoning. We are right now living through a reckless Keynesian experiment with massive deficit spending relative to low unemployment, with the government having devised programs to temporarily boost GDP in the short run. But this government spending isn’t lifting long-term growth; it’s stealing from future growth.
In the meantime, higher short-term interest rates mean businesses have the ability to lock in healthy nominal returns on cash with minimal risk. In turn, this should lead to a reduction in risk-taking and business investment.
In the meantime, we estimate that Real GDP expanded at a moderate 2.1% annual rate in the fourth quarter, mostly accounted for by an increase in consumer spending.
Consumption: “Real” (inflation-adjusted) retail sales outside the auto sector rose at a modest 1.3% annual rate in Q4 while auto sales declined at a 3.6% rate. However, it looks like real services, which makes up most of consumer spending, should be up at a moderate 2.4% pace. Putting it all together, we estimate that real consumer spending on goods and services, combined, increased at 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 1.8% growth rate for business investment, with gains in intellectual property leading the way, while commercial construction declined. A 1.8% growth rate would add 0.2 points to real GDP growth. (1.8 times the 13% business investment share of GDP equals 0.2).
Home Building: Residential construction is showing some resilience in spite of some lingering pain from higher mortgage rates. Home building looks like it grew at a 2.6% rate, which would add 0.1 points to real GDP growth. (2.6 times the 4% residential construction share of GDP equals 0.1).
Government: Only direct government purchases of goods and services (not transfer payments) count when calculating GDP. We estimate these purchases – which represent a 17% share of GDP – were up at a 1.7% rate in Q4, which would add 0.3 points to the GDP growth rate (1.7 times the 17% government purchase share of GDP equals 0.3).
Trade: Looks like the trade deficit shrank in Q4, as both exports and imports declined but imports declined faster. In government accounting, a drop in the trade deficit means faster growth, even if exports and imports both declined. We’re projecting net exports will add 0.3 points to real GDP growth.
Inventories: Inventory accumulation looks like it slowed down in Q4, meaning inventories generally went up, but at a slower pace than in Q3. That translates into what we estimate will be a 0.3 point drag on the growth rate of real GDP. When a recession hits, we expect inventory declines to play a significant role in the drop in GDP.
Add it all up, and we get a 2.1% annual real GDP growth rate for the fourth quarter. If we are right about a recession, this number is likely to go to zero or below sometime in first half of 2024.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Budgets And Governing
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 01/16/2024
The leaders of the House and Senate have come up with a new budget deal, and many people aren’t happy. It still needs passing by January 19th, or else the government, evidently, may shutdown. We doubt that this will happen, but the fight over government spending seems to drag on year after year after year.
It’s not hard to understand why. Non-defense spending by the federal government (including entitlements like Social Security) has climbed dramatically.
In other words, non-defense spending now consumes more than twice as much GDP every year as it did 60 years ago. It’s share of GDP is up 45% from just before the Great Recession, and it’s up 24% from the year before COVID. Government continues to take more and more of what the private sector produces, and it is heading for annual deficits of about $2 trillion.
The Great Recession and COVID were one off-events. Yet somehow, government spending never returned to pre-crisis levels following either. And because politicians have not been punished at the ballots for such unconstrained spending – or the resulting deficits – they have had little incentive to alter course.
This is why budget battles have turned consistently ugly in recent years. Repeated threats to not raise the debt ceiling or shut down the government because a budget can’t be agreed on have become commonplace. An ever- changing mix of politicians who want to see spending controlled face heavy pressure from every direction that they must go along to get along. But they still fight. And fight they should.
Total debt has ballooned at the same time the Fed lifted artificially low interest rates to fight the inflation that poor policies created, causing net interest expenses to skyrocket. In 2020, the net interest expense was $332.6 billion. In the past twelve months, it has totaled $730.4 billion. The Congressional Budget Office expects net interest expenses to rise to above $1 trillion per year after 2028. Lunacy.
While many think all the US has to do is raise tax rates, history suggests eliminating deficits this way is virtually impossible. The last period the budget was balanced was between 1998 and 2001. During those years, tax receipts averaged an all-time record of 19.4% of GDP, while total spending averaged just 18%.
This was the tail end of a miraculous period in modern US history. Starting with Ronald Reagan, and continuing through Bill Clinton, government spending fell as a share of GDP. The less government spends, the more there is left for private sector growth. Economic growth boomed, and that growth boosted tax receipts.
When spending gets too high, economic growth slows, as do tax receipts. Last year, the CBO’s budget forecast overestimated tax receipts by 11%, and underestimated spending by 9%. The bigger government gets, the more likely this happens year after year.
Back in the 1980s and 1990s, when the US was cutting spending, real GDP grew an average of 3.2% per year. In the past two years, in spite of historically large Keynesian deficits, real GDP has averaged just 1.7%.
We understand that the make-up of Congress creates difficulties for those who want to cut spending. But calling them names and accusing them of not being able to govern perpetuates the problem. Out of control spending, and huge deficits as far as the eye can see, are the real failure in governance.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Low Quality Growth
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 01/08/2024
Last Friday’s jobs report showed nonfarm payrolls up 216,000 in December, beating the consensus expected 175,000. Many are arguing that this was a huge number proving that the economy is not going into recession. But digging deeper into the data brings some doubt. In fact, it looks like the US is seeing low quality growth.
For example, yes, nonfarm payrolls came in better than expected in December, but not after adjusting for downward revisions of 71,000 to prior months. These downward revisions have now happened in ten out of the eleven past months. Over the past three months, private payrolls have increased a moderate 115,000 per month, tying for the slowest three-month pace of job gains since the COVID reopening started back in 2020.
What’s more, average hours worked by employees also fell by 0.2% in December. Despite more workers, we worked less in December than we did the month before, which is a headwind to growth. Losing 0.2% total hours of work is the equivalent to losing 228,000 jobs.
More importantly, the kind of jobs being added are of lower quality than we want. In 2023, nearly half of all jobs added were in the government and health care (which is heavily funded by government). Compare this to 2015 - 2019 (before COVID) when these two sectors accounted for a fifth of new jobs added.
Where else is the quality of growth low? Construction. Many people are talking about onshoring as manufacturing comes back to the US. Manufacturing facility construction is up 59.1% from a year ago and up 123.5% from two years ago. But this isn’t all private money. The government is funding many new projects, with the CHIPS Act and Inflation Reduction Act, artificially boosting spending in areas like manufacturing construction. But this deficit spending can’t last forever.
Real (inflation-adjusted) government purchases, which feed directly into the GDP numbers, are up 4.8% in the past year versus an average of 1.0% in the past twenty years. Meanwhile, recent government programs have been structured to multiply private-sector investment in politically-favored sectors, like “clean energy.” That, in turn, helped prop up economic performance last year – pushing out a recession that had looked likely to arrive at some point in 2023. But it’s low-quality growth that comes at a price. In order to spend on government favored projects, we must tax profitable entities in other areas. This redistribution does not add to growth, it just shifts it from one sector to another.
In fiscal year 2023, the U.S. government spent over $6.1 trillion dollars and ran a budget deficit of nearly $1.7 trillion dollars. That is fiscal madness. And it understates the true spending because the government was credited with a $333 billion “negative outlay” when the Supreme Court struck down President Biden’s plan to forgive student loans. Strip that out, and government spending in fiscal year 2023 represented roughly 24.0% of GDP. An incredibly high number for peacetime, especially for an economy that wasn’t in recession and had an unemployment rate below 4.0%.
It's only a matter of time before low quality growth stalls out. There are consequences to taking short term gains rather than fixing structural problems. Just ask California, Illinois, or New York.
In the meantime, the Federal Reserve is tasked with navigating treacherous terrain. Inflation is moderating but is still too high. The Fed’s choice to move from a scarce reserve system to a system of abundant reserves makes battling inflation that much tougher. And they are navigating with blinders on, willfully ignoring changes to the M2 money supply, down 3.0% in the past year.
We haven’t lost faith in the U.S. economy. Far from it. But we need to take an honest view on the sustainability of the current growth. For the sake of future progress, the government needs to stop digging the hole deeper and face issues head on. We will never beat China by trying to be like China. Government can never create wealth in the long run.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
The Housing Outlook: 2024
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 01/02/2024
Just because we still think the economy is headed for a recession, doesn’t mean we think the housing market is going to get killed.
The housing market was a mixed bag in 2023: housing starts and existing home sales were weak, while new home sales and home prices rose, in spite of the highest mortgage rates in twenty years. This year we expect modest gains almost all around: modest gains in housing starts, modest gains in sales, and modest gains in prices.
A recession, by itself, would have a negative effect on housing. But there are so many other factors affecting housing that we think the sector would weather the economic storm.
In terms of construction, builders started fewer homes in 2023 than in 2022, which was already down from the COVID peak in 2021. But builders have been consistently building too few homes since the bursting of the housing bubble about fifteen years ago. As a result, we expect a turnaround in 2024. However, the gains should be concentrated in single-family homes; the number of multi-family homes (think apartments and condos) under construction is at an all-time high already.
In terms of sales, it would be hard for the existing home market to get any worse in 2024. Sales have been handcuffed in 2022-23, for two reasons. First, temporary indigestion as mortgage rates rose. Second, homeowners who borrowed money at rock-bottom mortgage rates in 2020-21 have been very reluctant to sell. Who in their right mind would give up a mortgage with a fixed rate of something like 2.75% locked in for fifteen or even thirty years?
But with each passing year a gradually smaller share of homeowners will be locked in with those rock-bottom mortgage rates. Some of them will move anyhow, for one reason or another. In addition, mortgage rates should be lower this year than in 2023, helping boost sales among some prospective buyers and sellers.
Meanwhile, new home sales were up in 2023 and should continue to grow in 2024. Lower mortgage rates should help a little, as will the construction of more single-family homes.
The biggest surprise in the housing market last year was that prices increased consistently after falling in the second half of 2022. Through the first ten months of 2023, the national Case-Shiller index and the FHFA index were both up roughly 6.0%. We think the continued resilience of home prices largely reflects a lack of supply. However, a faster pace of construction in 2024 should put a ceiling on price gains in the year ahead.
The business cycle hasn’t been normal since COVID hit in 2020. COVID led to a massive surge in government stimulus, both monetary and fiscal, to fight widespread and overly draconian shutdowns. That was followed by tighter money in 2022-23, although government spending has continued to gush. Meanwhile, in certain ways, housing is still recovering from the housing bust that followed the bubble that peaked before the Financial Crisis in 2008-09.
Put it all together and we have a recipe for general improvement in housing even as the rest of the US economy slows down.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
A Mild Recession and S&P 4,500
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 12/26/2023
Very early this year our economics team got a pleasant surprise: Consensus Economics, which collects forecasts from roughly 200 economists around the world, rated us the most accurate forecasters of the United States for 2022, based on our forecasts for GDP and CPI. Unfortunately, we don’t expect a repeat award for 2023.
For 2022, we saw inflation and continued moderate growth. We were right. This past year, in 2023, we anticipated economic weakness late in the year, and put our S&P 500 target at 3,900. Instead, the economy remained resilient and stocks rallied much more than we thought. As we said a year ago: “if it turns out that Chairman Powell and the Federal Reserve have engineered a soft landing – no recession in 2023 and with the market ending 2023 confident of not having a recession in 2024 – then stocks should rally substantially in 2023 and easily beat our S&P 500 target of 3,900.” Today, that’s what most stock market investors are thinking: a soft landing has been achieved and they should therefore be optimistic about the future.
But we don’t think the economy is out of the woods yet. The consensus among economists is now that the economy will continue to grow in 2024, with a soft landing and no recession. We think that’s too bullish and see a mild recession with a -0.5% real GDP print on the way for 2024.
The yield curve has been inverted for more than a year and is likely to remain so well into 2024 and the M2 measure of the money supply is down 3.3% from a year ago, while commercial & industrial loans have also declined. Commercial construction has been temporarily and artificially supported by government subsidies in the past couple of years and should soon start faltering. Payrolls have grown very fast in the past year even with an unusually low unemployment rate, suggesting that businesses have over-hired.
Meanwhile, consumer spending looks set to slow. Government payouts, rent and student loan moratoriums, and temporary tax cuts during COVID led to bloated overall savings for many consumers. In turn, they could relax in 2022-23 and save a smaller part of their ongoing earnings than they normally would. But the artificial boost from these government actions is likely to finally run out in 2024, which suggests to us consumer spending will moderate significantly in 2024.
It's also important to realize how much the federal budget deficit expanded last year. The official deficit was about $1.7 trillion in FY 2023 but would have been $2.0 trillion if it hadn’t been for the Supreme Court striking down much of President Biden’s plan to forgive student loans. But that Court decision didn’t change the government’s cash flow; the Education Department just wrote up the value of its loan portfolio. In other words, the underlying cash flow situation for the federal government was no different than if we had run a deficit of $2.0 trillion, or about 7.4% of GDP. For last year, in FY 2022, excluding the student loan scoring, the deficit was about 4.0% of GDP. That’s a huge one-year spike in the deficit, which temporarily lifted spending.
But this won’t continue. The budget deficit won’t grow again in 2024, given the rally in stocks in 2023, big tax payments are likely due, which takes away this temporary stimulus.
What will happen to inflation? We think it keeps heading down in 2024 and may even finish the year at, or perhaps even temporarily below, the Federal Reserve’s 2.0% target. However, if we do hit 2.0% don’t expect to stay there for long. The Fed is likely to cut rates about as aggressively as the futures market now projects, about 150 basis points in 2024. And, unless the money supply keeps falling, inflation is likely to move back up in 2025 (and beyond); above the Fed’s 2.0% target.
What does this mean for stocks? The good news for stocks is that if the economy is weaker than expected and inflation keeps heading down, long-term interest rates will tend to decline, as well. That’s important because our Capitalized Profits Model takes nationwide profits from the GDP report and discounts them by the 10-year US Treasury yield, to calculate fair value.
If we use a 10-year Treasury yield of 3.50% the model says the S&P 500 is fairly valued, with current profits, at about 4,450. In other words, for the first time in many years, the US stock market is very close to fair value. And, the path of both profits and 10-year Treasury yields, in the next year, is uncertain.
We expect profits to be weaker than the consensus expects in 2024, and with Fed rate cuts of 150 basis points, the 10-year to end the year around 3.5%. Putting this all together, including the fact that the S&P 500 closed on Friday at 4,754, we think it finishes 2024 at 4,500, or lower.
Remember, this is not a trading model, and it doesn’t mean investors should run out and sell all their stocks, it just means investors need to be selective. The past few years have been the most difficult time to forecast in our careers. The US economy has never gone through COVID lockdowns before, plus a reopening, along with such massive peacetime fiscal and monetary stimulus. We understand many think we can do all this with little, or no, significant impact on the economy. We don’t believe this conventional wisdom. 2024 will be a tough year.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Greedy Innkeeper or Generous Capitalist?
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 12/18/2023
The Bible story of the virgin birth is at the center of much of the holiday cheer this time of year. The book of Luke tells us that Mary and Joseph traveled to Bethlehem because Caesar Augustus decreed a census should be taken. Mary gave birth after arriving in Bethlehem and placed baby Jesus in a manger because there was “no room for them in the inn.”
Some people think Mary and Joseph were mistreated by a greedy innkeeper, who only cared about profits and decided the couple was not “worth” his normal accommodations. This version of the story (narrative) has been repeated many times in plays, skits, and sermons. It fits an anti-capitalist mentality that paints business owners as greedy, or even evil.
It persists even though the Bible records no complaints and there was apparently no charge for the stable. It may be the stable was the only place available. Bethlehem was over-crowded with people forced to return to their ancestral home for a census – ordered by the Romans – for the purpose of levying taxes. If there was a problem, it was due to unintended consequences of government policy. In this narrative, the government caused the problem.
The innkeeper was generous to a fault – a hero even. He was over-booked, but he charitably offered his stable, a facility he built with unknowing foresight. The innkeeper was willing and able to offer this facility even as government officials, who ordered and administered the census, slept in their own beds with little care for the well-being of those who had to travel regardless of their difficult life circumstances.
If you must find “evil” in either of these narratives, remember that evil is ultimately perpetrated by individuals, not the institutions in which they operate. And this is why it’s important to favor economic and political systems that limit the use and abuse of power over others. In the story of baby Jesus, a government law that requires innkeepers to always have extra rooms, or to take in anyone who asks, would “fix” the problem.
But these laws would also have unintended consequences. Fewer investors would back hotels because the cost of the regulations would reduce returns on investment. A hotel big enough to handle the rare census would be way too big in normal times. Even a bed and breakfast would face the potential of being sued. There would be fewer hotel rooms, prices would rise, and innkeepers would once again be called greedy. And if history is our guide, government would chastise them for price-gouging and then try to regulate prices.
This does not mean free markets are perfect or create utopia; they aren’t and they don’t. But businesses can’t force you to buy a service or product. You have a choice – even if it’s not exactly what you want. And good business people try to make you happy in creative and industrious ways.
Government doesn’t always care. In fact, if you happen to live in North Korea or Cuba, and are not happy about the way things are going, you can’t leave. And just in case you try, armed guards will help you think things through.
This is why the Framers of the US Constitution made sure there were “checks and balances” in our system of government. These checks and balances don’t always lead to good outcomes; we can think of many times when some wanted to ignore these safeguards. But, over time, the checks and balances help prevent the kinds of despotism we’ve seen develop elsewhere.
Neither free market capitalism, nor the checks and balances of the Constitution are the equivalent of having a true Savior. But they should give us all hope that the future will be brighter than many seem to think.
(We’ve published a version of this same Monday Morning Outlook during Christmas week, each year, since 2009.)
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
What Should the Fed Do? How About Nothing?
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 12/11/2023
For the first time in roughly fifteen years, interest rates in the United States are about right. In economics, we call it the “neutral” or “natural” rate. The Taylor Rule says rates should be higher, and our model that uses nominal GDP growth (real GDP plus inflation) says the same thing. But both these models rely on data that is still distorted by COVID.
A simpler approach is to assume interest rates should be “Inflation Plus.” If we judge current inflation using an average of the Cleveland Median CPI (up 5.3% from a year ago) and overall total CPI (up 3.2% from a year ago) we get 4.2%. “Plus 1%” says rates should be roughly 5.2%. And that’s almost exactly where the federal funds rate is today.
This is a big change. Between 2008 and today, the Federal Reserve held the funds rate below inflation roughly 83% of the time. These excessively low rates have created problems.
Banks have hundreds of billions of dollars of mark-to-market losses and government-funded green new deal projects are facing serious problems because they are not profitable at current neutral interest rates. In other words, holding rates down artificially, like the Fed did for years, may make things look OK, but it can’t last forever.
At the same time, the Fed grew the M2 measure of money so rapidly in 2020-21 that inflation was easy to see coming. But now the M2 measure of money is contracting. So, with money contracting and interest rates near normal, it seems appropriate to pause. Especially given the fact that tighter money seems to be helping inflation come back down from its post COVID spike.
But it is certainly not time to claim victory and return to an environment of artificially low rates. That would risk repeating the 1970s, when Arthur Burns cut rates before eradicating inflation. If, as we suspect, the US economy enters recession in 2024, the political pressure on the Fed to cut rates and restart QE will be intense. But it would be a big mistake unless inflation continues to fall and thereby reduce the “neutral” interest rate. All it would do is continue the mistakes of the past fifteen years.
One interesting thing we have observed is how much bank regulators, Fed members, and Treasury officials have shifted their thinking. Back in 2008, Hank Paulson, Ben Bernanke and Sheila Bair religiously adhered to mark-to-market (MTM) accounting. We still blame this accounting convention for the financial panic that ensued. But that panic was used to justify growing the Fed’s balance sheet by trillions of dollars with QE and supporting TARP, which grew the size of the federal government.
These policies were supposed to make the US financial system safer, but they didn’t. Because the Fed became so powerful and flooded the banking system with deposits (at artificially low rates), bank balance sheets now have an estimated $675 billion in losses on them.
Interestingly (and thankfully) banks don’t have to mark these assets to market anymore. It would wipe out almost a third of bank capital. But what happened to all these MTM believers? Did they only believe in MTM accounting when they could blame it on banks? Now that it is clear the Fed’s policies caused the losses, are they trying to avoid blame?
The bottom line is that those who think the Fed can just manage its way out this easily, cutting rates to offset the pain of recession (or avoid one entirely), may not be correct. Many seem to have submitted to “state-run capitalism.” But history shows it has never really worked. The Fed is likely to “do nothing” this week and holding that position in 2024 might not be a bad thing.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Disinflation, Not Deflation
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 12/04/2023
New home prices are much lower than a year ago. The average price of a new home sold in October was 10.4% lower, while the median price was down 17.6%.
Records on new home prices go back all the way to the Kennedy Administration and never before has the median new home price dropped so much in twelve months, even during the bursting of the housing bubble in 2007-11. Is this a signal that monetary policy has become excruciatingly tight, that deflation – an outright and generalized drop in consumer prices – is about to grip the US economy?
Hardly.
In fact, deflation doesn’t even have a grip on the housing market. New home prices only include the prices for the new homes sold each month, which in the past year has averaged about 55,000 per month. That’s out of a total housing stock of about 145 million homes. In other words, new home prices reflect what’s going on each month with only about 0.04% of all homes.
Another big problem with just looking at prices for new homes sold is that those sold in October 2023 might be very different in size and quality than the new homes sold a year ago. Mortgage rates are higher, so many new home buyers are cropping their appetites, buying smaller homes to reduce their projected future mortgage payments. And builders are reacting to this, building smaller, less expensive homes. As a result, the average and median prices are falling, but not the price per square foot.
Better gauges of national home prices include the Case-Shiller index and the FHFA index, which are designed to adjust for the quality of homes. They also attempt to track the sales price of the same homes over time. These two indexes show home prices up 3.9% and 6.0% in the past year, respectively. In other words, no deflation. Home prices are not really falling.
And, when politics gets involved with economic data, confusion is often the result. When you hear that “inflation is falling” what that means is that prices are still rising, just not as fast as they were a year ago. The PCE price index, the Fed’s favorite measure for inflation, is up 3.0% in the past year versus a gain of 6.3% in the year ending in October 2022. Core PCE prices, which exclude food and energy, are up 3.5% in the past year versus a gain of 5.3% in the year ending in October 2022.
We expect this process to continue, with consumer prices climbing, but at a slower pace. Yes, they might fall in a particular month when energy prices drop, but even in those months core prices will continue to rise.
It’s important to remember that although the M2 measure of the money supply is down 4.5% from the peak in July 2022, that follows the surge of 40% that preceded it. That huge increase is still wending its way into the economy, and it would be crazy to try to take all that money back out. That would cause a massive deflationary problem. As a result, the general price level is permanently higher than the path it was on pre-COVID.
The bottom line is that the stance of monetary policy is tight enough to keep bringing inflation down in 2024. But don’t expect it to stay there so long that general prices start consistently falling. At present, the futures market is pricing in a drop in short-term interest rates of about 1.25 percentage points. We think the rate cuts will be steeper, the front edge of a shift in policy that will eventually cause an echo of the 2021-23 inflation problem in the years ahead. Unfortunately, like the 1970s.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Argentina: Is the Pendulum Swinging, Again?
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 11/27/2023
When Argentina entered the 20th Century, its prospects looked bright. On a per person basis, its economy was on par with Canada and Sweden and about two-thirds of the United States.
This all changed in 1946 when the country elected Juan Peron to the presidency. Peron launched plans to foster social justice through economic redistribution. The government sector grew rapidly (spending and money printing) and very high inflation (300%+) became the norm. Standards of living plummeted.
Without a change in policies, inflation could not be eradicated. Then, in the 1990s, Argentina tried a currency board arrangement where each Argentine peso was backed by one American dollar. Like the old-fashioned gold standard before the creation of the Federal Reserve, each unit of Argentine currency was backed by something that held its value. That currency board system worked for about a decade, bringing inflation down to US levels and spurring a decade of solid economic growth.
However, it broke down in 2001-02, largely because government spending never really subsided. When the government couldn’t print new money, it borrowed. Investors (correctly) thought politicians would abandon the currency board and let the value of the peso fall at the first sign of economic trouble. And that’s exactly what happened.
Now Argentina finds itself with another lost decade of growth and hyper-inflation. Recently, Argentina’s per person GDP stood less than 20% of US levels, and below even Russia.
But last month brought a political earthquake: the presidential election was won in a landslide by Javier Milei, a libertarian economist, and an unbridled and outspoken critic of socialism and supporter of free-market capitalism.
Milei wants to end the Argentine peso and central bank completely and just use the US dollar as the country’s currency. That way, re-introducing the peso would be very hard, so Argentines could be confident the government wouldn’t devalue again. He wants to slash government spending, including spending on the social safety net and get rid of lots of government agencies.
Unfortunately, he has his work cut out for him. Although he’s popular with voters he doesn’t come from a political party with widespread support in the legislative branch. As a result, it remains to be seen how much Milei can accomplish.
And yet this isn’t the only big shift at the polls in recent months, with voters in New Zealand and the Netherlands swinging toward leaders seeking some major changes.
The long historic battle between those who support wealth creation and those who support wealth redistribution, continues. The pendulum is starting to swing. We think much of this recent pattern is due to voters getting fed up with governments that are too big. Even the election of Geert Wilders in the Netherlands, ostensibly about immigration has a big government component, due to taxpayer-funded resources that, right or wrong, voters think recent immigrants’ demand.
When governments are already very large, and inflation rises while growth suffers, it’s harder for the left to make bigger government appealing to voters, and easier for the right to make trimming government look attractive.
The pendulum is swinging toward smaller government. If leaders fulfill this desire, investors around the globe will have reason to cheer. While Argentina has followed a different rhythm than many Western countries, the elections of Margaret Thatcher and Ronald Reagan changed the direction of global economic growth. Is it happening again?
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Consumer Spending Set for Slower Growth
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 11/20/2023
Now that we’re about to enter the Christmas shopping season, expect even more focus than usual on the consumer over the next several weeks.
We are supply-siders and so usually cringe when we hear analysts and investors dwell on consumption as if it were the ultimate arbiter of economic growth. Ultimately the economy depends on production, which, in turn, hinges on entrepreneurship and innovation, the labor supply, as well as the health of cultural institutions like property rights and freedom of contract.
The government can affect these factors by raising or reducing tax rates, increasing or lowering spending, and adding or cutting regulations. Meanwhile, monetary policy can lead to temporary deviations from these long-run factors, with a policy that raises or reduces inflation.
On top of all this, the wild policy response to COVID – with enormous government checks sent directly to bank accounts – left consumers with more purchasing power than they’d normally have, given output. In turn, that has meant following the consumer is one way to gauge the extra inflationary impulse still remaining in the US economy, as well as the timing of the onset of the tighter monetary policy – the M2 measure of the money supply has dropped 4.4% – that the Federal Reserve began implementing last year.
In the year ending in September, “real” (inflation-adjusted) consumer spending is up 2.4%, no different than the growth rate in the ten years immediately prior to the onset of COVID. However, there are multiple reasons to believe that growth rate should soon decline.
First, much of the increase in spending in the past year has been driven by increases in jobs. Total payrolls are up 243,000 per month in the last year, which is unusually fast given an unemployment rate below 4.0%. A slowdown in job growth should limit the growth in consumer purchasing power.
Meanwhile, consumers have been eating into the excess saving they were able to accumulate during COVID, back when the government was passing out checks with reckless abandon. Immediately prior to COVID, in February 2020, US consumers, in the aggregate, were accumulating savings at a $1.28 trillion annual rate. That’s personal income, minus taxes, minus consumer spending. By contrast, in September 2023, consumers were saving at a $690 billion annual rate.
For the time being, accumulating savings at a slower rate makes sense; the government showered consumers with checks during COVID and so they got used to not having to save for themselves. But eventually we expect that old pace of saving to reassert itself. Even if it takes two years to do so, an increase in the pace of saving back to $1.28 trillion per year should trim consumer spending by about 1.5 percentage points per year. That alone could take a pace of real consumer spending growth of 2.4% per year down to less than 1.0% per year. Ouch!
Then there are student loan payments that have finally re-started. By itself, that’s unlikely to be a major issue; we estimate the effect at about 0.2% of consumer spending. But it should be a small headwind.
None of this means that consumer spending has to plummet anytime soon. But we don’t need consumer spending to drop in order to have a recession. That’s what happened in 2001, for example, when real consumer spending rose a respectable 2.0%, while the unemployment rate rose almost two percentage points, as well.
Some economists are already taking a victory lap because they didn’t forecast a recession and a recession hasn’t started yet. But we think they’re declaring victory too early. Some of them say that we never should have been worried about a recession while inflation fell because the surge in inflation was due to supply-chain issues, and then the reduction in inflation has been due to fixing those issues.
The problem with their theory is that they ignore the link between the surge in the money supply in 2020-21 and the inflation that followed, as well as the drop in money and the reduction in inflation this year. They think it’s a coincidence, but we think they’re going to get a rude awakening in the year ahead.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
The Election Outlook is a Tax Outlook
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 11/13/2023
We’re now less than a year away from a presidential election and control of the White House, Senate, and House are all up for grabs. One of the biggest issues facing the winners is going to be how to handle the federal budget.
As we set out a couple of months ago, the US is currently running the most reckless budget in the history of the country. Never before has the deficit soared so quickly to such a high level when the US is still at peace and not in recession.
No wonder Moody’s just announced it was downgrading the outlook for US debt to “negative” from “stable.” They claim it’s because of political “polarization” on top of the deficit itself, but that seems odd. Moody’s makes it sound like we’d be better off if no one on Capitol Hill cared at all about the deficit, because then our institutions wouldn’t be polarized! The way we see it, thank goodness there are some politicians focused on the deficit, even if that’s what’s causing more polarization.
For the presidency, we think 2024 is likely to be a rerun of 2020, Biden versus Trump, although retiring Senator Joe Manchin may throw a monkey-wrench into the election if he can find a Republican to run with. At this point, we think Trump would be a slight favorite; but will face constant challenge given how much of the electorate dislikes him. Meanwhile, the House of Representatives is likely (but not definitely) going to go to the party that wins the White House.
The Senate is an easier call, with the GOP in excellent political position to win for fundamental reasons. At present the GOP has 49 seats. But Republicans don’t have to defend any seats in blue (Democratic) states and only have to defend one seat in a purple state, Florida, which is very unlikely to suddenly lurch back toward the Democrats, given the recent popularity of Republican governance in that particular state. In other words, we do not see a route for the Democrats to win any seats now held by the GOP.
However, there are multiple seats where the Democrats are vulnerable. Now that Joe Manchin is retiring, it’s extremely likely that the GOP picks up West Virginia with popular Governor Jim Justice having thrown his hat in the ring. Republicans are also favored to knock off an incumbent Democrat in Ohio, plus have a shot in Montana as well as in Arizona, and Nevada.
In turn, the election will have a major influence on what happens to the Trump tax cuts originally enacted in 2017 and which are set to expire at the end of 2025. We think the odds of a GOP sweep are about 30%, which would probably result in a full extension of those tax cuts and the GOP pushing through substantial reforms to Medicaid as well as major budget cuts outside of national defense. If the Democrats sweep – we put those odds at about 20% – look for substantial tax hikes, on individuals and businesses, alike, and not just on the “rich.”
That leaves a 50% chance of mixed government, in which case expect modest tax hikes, with a slightly higher top rate for individuals, a slightly higher rate on companies, but with lots of talk and little action on cutting government down to size. And without spending cuts, expect negative outlooks to turn into outright and deserved downgrades in the years ahead.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Government Is Too Darn Big
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 11/06/2023
Two weeks ago, the yield on the 10-year Treasury Note was hovering around 5%, and the S&P 500 was in contraction territory, down over 10%. But last week, the 10-year yield dipped to 4.6%, while the S&P 500 saw a 6% gain. This market volatility is attributed to changing sentiments: 1) There was a belief that the Federal Reserve had lost control, but now, 2) it seems the Fed has achieved a "soft landing," bringing a semblance of stability.
While this may hold some truth, we remain cautious. If we step back and look at the US economy from a distance, things don’t really look so great. Our worries have roots all the way back in 2008, when the Fed altered its approach to monetary policy. The Fed shifted from a "scarce reserve" model to an "abundant reserve" model when it initiated Quantitative Easing, fundamentally changing how interest rates are determined.
In the past, banks occasionally lacked the reserves they were legally required to hold, prompting them to borrow from other banks with excess reserves through their federal funds trading desks, thus determining the federal funds rate through an active market. Today, banks are flush with trillions of excess reserves, eliminating the need for borrowing and lending reserves. Consequently, the federal funds trading desk has become obsolete.
So…if banks are not creating a market for federal funds, were does the rate come from? The answer: the Fed just makes it up. Literally makes it up. And, over the past fifteen years, the Fed has held the funds rate below inflation 83% of the time.
The last time the Fed kept rates artificially low was in the 1970s. The result was inflation, but even more importantly, banks and Savings & Loans lent at rates lower than they should have. The ultimate result was the dramatic downfall of the S&L industry, along with many banks, as the losses incurred from offering high interest rates to depositors while getting low rates from borrowers steadily eroded their capital.
Today, US commercial banks carry an estimated $650 billion loss in their “held to maturity” assets…but they don’t have to mark them to market. Just imagine if this was 2008 and Treasury Secretary Hank Paulson, Fed Chair Ben Bernanke and FDIC Chair Sheila Bair were in charge. They would have insisted on mark-to-market and we would need TARP 2.0 to bail out the banking system.
What the Fed will do is pay these private banks and other institutions roughly $300 billion this year just to hold reserves. Without this payment from the Fed to the banks, profits would be much lower and the losses on their books would be more painful.
The point we are making is that the Fed has made a mess of the banking system. While we've averted major crises thus far, it's the taxpayers who ultimately bear the burden. The $300 billion the Fed pays to banks doesn't appear out of thin air, and unless interest rates decrease significantly, these losses will accumulate. Why isn’t Elizabeth Warren fuming over this?
Like the 1970s and 1980s – because we don’t have mark-to-market accounting on these held-to-maturity assets – the banks can eventually earn their way out of this abyss. So, this doesn’t mean the economy will suffer, other than the fact that banks have less ability to make new loans.
This is exacerbated by the Fed engineering a decline in the M2 measure of money, which has fallen by 3.6% in the past year, the most substantial drop since the Great Depression.
Some of this decline is because since 2008 the Treasury Department has started holding a great deal of cash in its checking account at the Fed. For decades it held just $5 billion as a cash management tool. This number soared after QE started, and as of November 1, 2023, the Treasury General Account (TGA) at the Fed held $820 billion. This money is part of the Fed’s balance sheet, but does not count as M2. So, when the Treasury borrows from, or taxes the private sector, and then puts that money aside in its own TGA, it will lower M2. In other words, the Treasury has helped engineer a decline in M2. The Treasury could use this $820 billion to reduce debt, but it hasn’t, and taxpayers will pay roughly $40 billion per year in interest, just so the Treasury/Fed can hold this cash.
This new method of managing monetary policy appears fraught with risks. Instead of stabilizing banks, it has introduced instability, proved costly to taxpayers, and contributed to the worst inflation since the 1970s.
We aren’t saying that the economy can’t survive, but the idea that everything will turn out perfectly seems like wishful thinking. The government has expanded significantly since 2008, with federal government spending growing from 19% of GDP in 2007 to 25% last year, and the Fed's balance sheet has expanded from 6% of GDP in 2007 to 33% of GDP.
It's evident that we no longer operate in a free-market capitalist system. While government involvement in the economy is not new, it has reached unprecedented levels.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
It’s the Same Bear Market
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 10/30/2023
The S&P 500 closed at 4,117 on Friday, more than 10% below its recent peak in late July. Some are saying it’s a brand-new bear market for stocks. In this view there was a bear market in 2022, a bull market from October 2022 through July this year, and a new bear market that started in August.
We don’t think this is the appropriate way to look at things. This is not a new bear market. Instead, it’s the same bear market. We had a bear market in 2022, a temporary rally, and then the bear market reasserted itself.
The driving forces behind the ongoing bear market have not changed. Federal policy of easy money and extremely loose fiscal policy during COVID kept a serious recession at bay. That is basically over now. The M2 measure of money is down 3.6% in the past twelve months. Second, the massive episodes of COVID-era government spending/stimulus had to eventually wear off, which is revealing lots of malinvestment and now generating economic headwinds.
We think much of the headwinds from these shifts are still in front of us. Yes, the economy grew at a rapid pace in the third quarter but that includes contributions from consumer spending and inventory accumulation that were unsustainably hot. Meanwhile, business investment should slow as companies can earn robust returns by hoarding cash with little to no credit risk. Speaking of interest rates, they are now above inflation across the yield curve. The artificial boost from artificially low rates is gone.
This is why we remain bearish. At the end of last year we forecast that the S&P 500 would finish 2023 at 3,900 and we haven’t budged since, remaining bearish throughout the rally that took the S&P 500 all the way up to 4,600 this summer.
It hasn’t been easy taking this position. Equities tend to trend upward over long periods of time, as the real economy and profits tend to grow, and the price level rises, as well. We still believe the US future is relatively bright: entrepreneurs are still creating and innovating, and artificial intelligence shows great promise. We are also hopeful that sometime in the next few decades there will be major technology breakthrough in the energy sector. Our natural tendency is toward bullishness.
Clearly, we are not “permabulls” and never have been. From 2009, all the way through 2021 we remained bullish. We didn’t run with the herd of other forecasters worried that the world had come to an end in 2008. And, while we are bearish today, we don’t think it’s the end of the world now.
Eventually, stock prices will reflect fair value. More importantly, we expect the political pendulum to swing back toward the center. Big government directed economies eventually suffer…then recover when policy shifts back.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Growth Surge in Q3 Masks Weak Trend
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 10/23/2023
We still think a recession is coming, but it definitely didn’t start in the third quarter. Instead, as we set out below, it looks like real GDP expanded at a 4.7% annual rate. If we are right about that number, that would be the fastest pace of growth for any quarter since 2014, with the exception of the re-openings from COVID in 2020-21.
Keep in mind, though that even with growth that fast, the growth rate since the end of 2019 – the pre-COVID peak – would be only 1.9% per year, reflecting an underlying trend that is still slow.
Why do we still think a recession is coming? Because after the surge in money creation in 2020-21, monetary policy started getting tight in 2022. In the past year the M2 measure of the money supply is down 3.7%. Meanwhile the yield curve (we like to compare the 10-year Treasury yield to the target federal funds rate) has been inverted since late 2022 and is likely to stay that way for at least the next several months.
Higher short-term interest rates mean businesses have the ability to lock in healthy nominal returns on cash with minimal risk. In turn, this should lead to a reduction in risk-taking and business investment.
Meanwhile, jobs are still expanding rapidly. Payrolls are up 2.1% in the past year. During the economic expansion that happened before COVID (mid-2009 through early 2020), a pace that fast (2.1% or more) only happened when the unemployment rate was about 5.5%, which meant plenty of workers still available for hire. Now it’s happening when the unemployment rate is less than 4.0%. This suggests employers are out over their skis and vulnerable to any softness in demand.
The bottom line is that the economy grew rapidly in Q3 but Q4 and beyond are likely to be much slower.
Consumption: “Real” (inflation-adjusted) retail sales outside the auto sector rose at a 3.7% annual rate in Q3 while it looks like real services, which makes up most of consumer spending, should be up at about a 4.0% pace. The one weak spot was autos and light trucks, which declined at a 2.5% rate. Putting it all together, we estimate that real consumer spending on goods and services, combined, increased at a strong 4.1% rate, adding 2.8 points to the real GDP growth rate (4.1 times the consumption share of GDP, which is 68%, equals 2.8).
Business Investment: We estimate a 4.5% growth rate for business investment, with gains in intellectual property and equipment leading the way while commercial construction was roughly unchanged. A 4.5% growth rate would add 0.6 points to real GDP growth. (4.5 times the 14% business investment share of GDP equals 0.6).
Home Building: Residential construction is showing some resilience in spite of some lingering pain from higher mortgage rates. Home building looks like it grew at a 7.5% rate, which would add 0.3 points from real GDP growth. (7.5 times the 4% residential construction share of GDP equals 0.3).
Government: Only direct government purchases of goods and services (not transfer payments) count when calculating GDP. We estimate these purchases – which represent a 17% share of GDP – were up at a 1.8% rate in Q3, which would add 0.3 points to the GDP growth rate (1.8 times the 17% government purchase share of GDP equals 0.3).
Trade: Looks like the trade deficit shrank in Q3, as exports expended rapidly in spite of foreign economic weakness. We’re projecting net exports will add 0.5 points to real GDP growth.
Inventories: Inventories look like they grew a little bit faster in Q3 than in Q2, suggesting they’ll add about 0.2 points to the growth rate of real GDP. When a recession hits, we expect inventory declines to play a significant role in the drop in GDP.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
