Implications:  New home sales came in stronger than expected in March, driven by broad-based gains as more inventories give buyers a greater number of options to choose from. Notably, the 8.8% gain in March was the largest in more than a year.  It looks like the upward trend in new home sales that began in 2022 as the economy reopened is still intact, though volatility in interest rates continues to play an outsized role.  Mortgage rates have been surging again recently due to a recent string of bad inflation reports that have led to expectations of fewer cuts by the Federal Reserve in short term interest rates later this year.  Expect an impact on new home sales in April’s report (due in a month) as higher financing costs once again hit affordability. Assuming a 20% down payment, the rise in mortgage rates since the Federal Reserve began its current tightening cycle amounts to a 28% increase in monthly payments on a new 30-year mortgage for the median new home.  The good news for potential buyers is that the median sales price of new homes has fallen 13.3% from the peak in 2022.  However, it’s important to note that this drop in median prices is likely due to the mix of homes on the market including more lower priced options as developers complete smaller properties. Supply has also put more downward pressure on median prices for new homes than existing homes.  The supply of completed single-family homes is up nearly 190% versus the bottom in 2022. Total inventories have continued to climb higher as well, hitting a new post pandemic high in March. This contrasts with the market for existing homes which continues to struggle with an inventory problem, often due to the difficulty of convincing current homeowners to give up the low fixed-rate mortgages they locked-in during the pandemic.  But this does not mean that housing is getting more affordable per square foot, with the Census Bureau reporting median prices on this basis up 45% from 2019 to 2022, the most recent data available. Though not a recipe for a significant rebound, more inventories giving potential buyers a wider array of options will continue to put a floor under new home sales.  One problem with assessing housing activity is that the Federal Reserve held interest rates artificially low for more than a decade.  With rates now in a more normal range, the sticker shock on mortgage rates for potential buyers is very real.  However, we have had strong housing markets with rates at current levels in the past, and as long as the job market remains strong, homebuyers will continue to adjust.  In manufacturing news this morning, the Richmond Fed index, a measure of mid-Atlantic factory activity, rose to -7.0 in April from -11.0 in March.

Click here for a PDF version

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 spending wear off.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist 

Click here for a PDF version

In this week’s “Three on Thursday,” we explore the Personal Consumption Expenditures (PCE) Price Index, which became the Federal Reserve’s preferred inflation gauge starting in 2000. This shift occurred after Federal Reserve Chairman Alan Greenspan highlighted its advantages in The Monetary Policy Report to Congress. The Fed favors the PCE Price Index over the Consumer Price Index (CPI) for several reasons.

Click here for a PDF version

Implications:  Existing home sales took a widely expected breather in March following the largest monthly gain in a year in February. While sales activity has finally bottomed it looks like any significant recovery is still facing headwinds from mortgage rates that remain above 7%. Mortgage rates had been dropping in early 2024, but that trend has recently reversed. The culprit is a recent string of bad inflation reports that have cast doubts on the Federal Reserve following through with rate cuts this year. Meanwhile, home prices appear to be rising again, although modestly, with the median price of an existing home up 4.8% from a year ago.  The result is that affordability is still a big concern for buyers.  Assuming a 20% down payment, the rise in mortgage rates since the Federal Reserve began its current tightening cycle in March 2022 amounts to a 34% increase in monthly payments on a new 30-year mortgage for the median existing home.  Eventually, the housing market can adapt to these increases but continued volatility in financing costs will cause some indigestion.  The other major headwind for sales has been that many existing homeowners are reluctant to sell due to a “mortgage lock-in” phenomenon, after buying or refinancing at much lower rates before 2022.  This continues to limit future existing sales (and inventories).  However, there are signs of progress with inventories rising 14.4% in the past year.  That said, the months’ supply of homes (how long it would take to sell existing inventory at the current very slow sales pace) was 3.2 in March, well below the benchmark of 5.0 that the National Association of Realtors uses to denote a normal market.  A tight inventory of existing homes means that while the pace of sales looks like 2008, we aren’t seeing that translate to a big decline in prices.  Putting this together, we expect a modest recovery in sales in 2024.  In other news this morning, initial claims for jobless benefits remained unchanged last week at 212,000, while continuing claims rose by 2,000 to 1.812 million.  The figures are consistent with continued job gains in April. Finally, on the manufacturing front, the Philadelphia Fed Index, a measure of factory sentiment in that region, jumped to +15.5 in April from +3.2 in March.

Click here for a PDF version

Implications:  Industrial production continued to rebound in March, rising for a second month due to broad-based gains. The manufacturing sector was the main source of strength in today’s report, with activity rising 0.5%.  Auto production jumped 3.1% in March and has been a big driver of activity so far in 2024. This measure is up at a 10.1% annualized rate in the past three months, likely the result of production still getting back on track following large scale strikes late last year. Meanwhile, non-auto manufacturing (which we think of as a “core” version of industrial production) posted a moderate gain of 0.3% in March. The production of high-tech equipment also rose in March and is up 14.1% in the past year, the strongest growth of any major category.  This likely reflects investment in AI as well as the reshoring of semiconductor production. Notably, activity here has begun to slow recently signaling that the initial burst due to the CHIPS Act may finally be wearing off.  The utilities sector (which is volatile and largely dependent on weather) was also a tailwind in today’s report, rising 2.1% in March.  Finally, the one source of weakness in March came from the mining sector, with activity falling 1.4%.  Broad-based declines in oil and other mineral extraction more than offset a small increase in natural gas production.  However, given the recent jump in energy prices, we expect a rebound in mining in the next couple of months.   

Click here for a PDF version

Implications:  Housing starts posted the largest monthly decline in March since the worst of the COVID pandemic, coming in well short of consensus expectations.  However, this follows a surge in starts in February and we do not see March as a sign of persistent weakness ahead in home building.  While the data have been very choppy since the Federal Reserve began the current tightening cycle two years ago, it looks like construction activity has bottomed; even with the large drop in March, starts are still above the level from last August.  Keep in mind that many owners of existing homes are hesitant to list their homes and give up fixed sub-3% mortgage rates, so many prospective buyers have turned to new builds as their best option. This has boosted demand for developers and should help construction activity going forward.  The problem is that with recent inflation reports having come in hotter than expected, the markets – and the Fed itself – seem increasingly doubtful about near-term rate cuts.  As a result, long-term interest rates have gone up including mortgage rates.  In turn, this could generate a temporary headwind for home sales and housing starts in April.  Looking at the details of the report, the slowdown in construction in March was broad-based with three out of four major regions and both single-family and multi-unit starts contributing.  Housing permits and completions also took a breather in March, dropping 4.3% and 13.5%, respectively.  Another recent theme is the split between single-family and multi-family development.  Over the past year, the number of single-family starts is up 21.2% while multi-unit starts are down 44.3%.  Permits for single-family homes are up 17.4% while multi-unit home permits are down 20.2%.  This huge gap in the data is due to the unprecedented nature of the last four years since COVID began.  While we don’t see housing as a major driver of economic growth in the near term, we don’t expect a housing bust like the 2000s on the way, either.  Builders built too few homes in the decade before COVID and that shortage should support home prices in the years ahead.  In other housing news, the NAHB Housing Index, a measure of homebuilder sentiment, remained at 51 in April.  This marks the second month in a row that the index is above 50 since last Summer, signaling that a greater number of builders view conditions as good versus poor.

Click here for a PDF version

Implications:  Retail sales beat expectations in March, rising 0.7% for the month versus a consensus expected gain of 0.4%, while previous months were revised higher.  Factoring these in, retail sales grew an even faster 1.3%.  These figures add to a trove of recent reports pulling the Federal Reserve away from rate cuts starting in June.  Sales rose in eight of thirteen major categories for the month, led by a robust 2.7% gain in nonstore retailers (think internet and mail-order), followed by a 2.1% increase at gas stations, which rose largely due to higher gas prices in March.  The largest decline in March was a 0.7% drop for autos.  “Core” sales, which exclude volatile categories such as autos, building materials, and gas stations — and is a crucial measure for estimating GDP — surged 1.0% in March (+1.4% including revisions to prior months).  After looking weak in the first two months of 2024, these sales ended up increasing at a 2.2% annual rate in Q1 versus the Q4 average.  It’s important to remember that a key driver of overall spending is inflation.  While overall retail sales are up 4.0% in the last year and sit at a record high unadjusted for inflation, “real” (inflation-adjusted) retail sales are up just 0.5% in the last year, and have remained stagnant for nearly two years after peaking in April 2022.  It has been 40 years since the US had an inflation problem, so investors should be aware that it can distort data.  Our view remains that the tightening in monetary policy since 2022 will eventually deliver a recession.  In other news this morning, the Empire State Index, a measure of New York factory sentiment, rose to -14.3 in April from -20.9 in March.

Click here for a PDF version

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.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

Click here for a PDF version

Implications:   Do you hear that sound?  It’s the door creaking closed on the chances for a June rate cut. While the producer price index rose a modest 0.2% in March, that comes on the back of above-trend increases the prior two months.  Through the first three months of 2024, producer prices rose at a 4.4% annualized pace, while year-ago comparisons are on the rise and now back above 2.0% for the first time since April of last year.  Paired with consumer price data out yesterday showing inflation re-accelerating, the Fed is unlikely to feel the confidence that the inflation fight is won.  Looking at March itself, lower energy costs helped keep producer prices contained, down 1.6% on the back of falling gasoline prices, while food prices – the other typically volatile category – rose 0.8% on a jump in costs for processed poultry.  Stripping out these two components shows “core” prices rose 0.2% in March, following an outsized 0.5% increase in January and a 0.3% rise in February.  While the Fed can take some solace in noting the twelve-month rise in core prices has eased since peaking at 9.7% back in March of 2022, they remain up 2.4% in the last twelve months and accelerated to a 4.2% annualized rate over the first three months of 2024.   The 0.2% rise in core inflation in March was led by services, up 0.3%, while goods prices outside of food and energy rose 0.1%.  The largest price increases came from securities brokerage, commercial equipment wholesaling, and airline passenger services, which were partially offset by lower costs for traveler accommodations and auto retailing.  Further back in the pipeline, processed goods prices fell 0.5% in March and are down 1.7% in the past year, while unprocessed goods prices declined 1.9% in March and are down 7.1% in the past year.  Further easing in inflation will come should the Fed have the patience to let a tighter monetary policy do its work.  But inflation risks rearing its ugly head once again should the Fed falter and cut rates too quickly.  The markets – and the Fed itself – seem increasingly doubtful that rate cuts are near. And for good reason. In other news this morning, initial claims for jobless benefits fell 11,000 last week to 211,000, while continuing claims rose by 28,000 to 1.817 million.  The figures are consistent with continued job gains in April.

Click here for a PDF version

In this week’s edition of “Three on Thursday,” we look at the Federal Reserve’s financials through year-end 2023. Back in 2008, the Federal Reserve (the “Fed”) embarked on a novel experiment in monetary policy by transitioning from a “scarce reserve” system to one characterized by “abundant reserves.” In addition to inflation, this experiment has resulted in some other developments that are worrisome.

Click here to view the report