Implications:  New home sales came in weaker than expected in June, posting another decline following the largest monthly drop since 2022.  It looks like activity is stuck in low gear, with sales having normalized roughly at the same pace they were in 2019 before COVID. With 30-year fixed mortgage rates still above 7%, some potential buyers may be delaying purchases in the hopes of widely expected rate cuts from the Federal Reserve improving affordability in the future. Assuming a 20% down payment, the rise in mortgage rates since the Federal Reserve began its current tightening cycle amounts to a 23% 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 9.3% from the peak in 2022. It does look like a small part of this decline reflects a lower price per square foot as developers cut prices.  The Census Bureau reports that from 2022 to 2023 (the most recent data available) the median price per square foot for single family homes sold fell 1.1%. While that decline is modest, it represents a stark reversal from the 45% gain from 2019 to 2022.  That said, most of the 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 over 200% versus the bottom in 2022. Total inventories have continued to climb higher as well, hitting a new post-pandemic high in June. 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.  Though not a recipe for a significant rebound, more inventories giving potential buyers a wider array of options will keep 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, and buyers started to believe those low rates were normal.  With rates now reflecting true economic fundamentals, 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 and buyers understand that the past was a mirage, it’s possible they will eventually adjust.  Finally, the Federal Reserve released monthly figures on the money supply yesterday showing M2 rose 0.3% in June and is up 1.0% in the past year.  After surging in the first two years of COVID, M2 declined from early 2022 through early 2023 and has since been close to flat.  As we mentioned in our recent MMO it looks like this is finally putting downward pressure on both inflation and the growth rate of nominal GDP.

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Implications:  The typically strong spring selling season failed to materialize in 2024, with activity falling 5.4% in June, the fourth decline in a row. It looks like the housing market remains stuck in low gear due to affordability. First, sales are still facing headwinds from mortgage rates that remain above 7% and some buyers are likely delaying purchases until after the Fed delivers on widely anticipated rate cuts. Second, home prices are rising again (hitting a new high in June) with the median price of an existing home up 4.1% from a year ago.  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 45% 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. Notably, sales of homes priced at $1 million and above have risen 3.6% in the past year versus a decline of 5.4% for all existing home sales. This demonstrates that, at least at the higher end of the market, both buyers and sellers are beginning to adjust to the new reality of higher rates. However, outside the most expensive segment many existing homeowners remain reluctant to sell due to a “mortgage lock-in” phenomenon, after buying or refinancing at much lower rates before 2022.  This remains a major impediment to activity by limiting future existing sales (and inventories).  However, there are signs of progress with inventories rising 23.4% in the past year.  That has helped push the months’ supply of homes (how long it would take to sell existing inventory at the current very slow sales pace) up to 4.1 in June, the highest since May of 2020 although still below the benchmark of 5.0 that the National Association of Realtors uses to denote a normal market.   A tight inventory of existing homes means that while the pace of sales looks like 2008, we aren’t seeing that translate to a big decline in prices.  In other news on the manufacturing sector, the Richmond Fed index, a measure of factory activity in the mid-Atlantic, fell to -17 in July from -10 in June.

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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.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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In this week’s edition of “Three on Thursday,” we examine some key high-frequency data to see how things stand a few years after the COVID-19 shutdowns of 2020. Many believed that the world would be forever changed and that things would never return to their pre-pandemic state. However, the data show that the post-COVID world resembles the pre-COVID world in many ways.

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Implications:  Industrial production continued to beat expectations in June, rising for the second month in a row due to broad-based gains in every major category.  Manufacturing was the biggest positive contributor, rising 0.4%.  Looking at the details, auto production was the biggest contributor to June’s gain, jumping 1.6%. That said, non-auto manufacturing (which we think of as a “core” version of industrial production) also posted a gain of 0.2% in June. What’s interesting about today’s report is that it shows activity in manufacturing has been broadening recently. We have been highlighting the production of high-tech equipment in these reports, which is up at a 13.3% annual rate in the past three months, likely the result of investment in AI as well as the reshoring of semiconductor production. This is consistent with the broader post-COVID trend of consumer preferences shifting away from goods and towards services leaving capital goods as the driver of manufacturing activity.  However, the demand for consumer goods seems to be reviving of late, with manufacturing activity in that sector up at a healthy 10.3% annual rate in the past three months. Notably, this is the fastest three-month pace since early 2021 as lockdowns were still in full effect.  The mining sector was also a tailwind in June, with activity increasing 0.3%.  Gains in the production of oil and gas more than offset a slowdown in the drilling of new wells and the extraction of other minerals.  Finally, the utilities sector (which is volatile and largely dependent on weather) was also a source of strength in June, rising 2.8%.  Part of the recent strength in industrial production has been a surge in utilities demand, which is up at an unsustainable 39.2% annualized rate in the past three months due to warmer than normal temperatures driving demand for air conditioning which will normalize in the months ahead.

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Implications:    Don’t get too excited about the jump in housing starts in June. Although they rebounded for the month, they remain below the pace of 2021-2023.  Moreover, the monthly rise was entirely due to a 19.6% jump in the volatile multi-family category, while single-family starts dropped to an eight-month low.  The good news for future homebuyers is that it looks like builders were focusing their efforts on completing projects in June, as completions surged 10.1% to a 1.710 million annual rate: the fastest pace since January 2007.  With strong completion activity and tepid growth in starts, the total number of homes under construction continues to fall, now down 6.9% through the first half of this year.  That is usually associated with a housing bust or recession.  The lack of construction is why home prices have remained elevated and are rising in most places while rents are still heading up in much of the country: we are building too few homes while lax enforcement of immigration laws mean rapid population growth.  We think government rules and regulations are likely the major hurdle for builders in much of the country, but home construction might also be facing headwinds from a low unemployment rate (which makes it hard to find workers) as well as relatively high mortgage rates.  Fitting the pattern, the NAHB Housing Index, a measure of homebuilder sentiment, fell to 42 in July from 43 in June.  A reading below 50 signals a greater number of builders view conditions as poor versus good.  No matter how you slice it, the home building sector seems strangely slow given our population growth and the ongoing need to scrap older homes due to disasters or for knockdowns, which is why we think government rules and regulations are likely a major problem.  However, there are some tailwinds for housing, as well.  For example, many owners of existing homes are hesitant to list their homes and give up fixed sub-3% mortgage rates, so many prospective buyers will need new builds.  In addition, Millennials are now the largest living generation in the US and have begun to enter the housing market in force, which represents a demographic tailwind for activity.  Putting it together, we don’t see housing as a major driver of economic growth in the near term, but we’re not expecting a housing bust like the 2000s on the way, either.  As the Fed eventually begins to cut rates, mortgage rates should trend lower as well, helping support housing later in 2024.

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Implications:   Soft, but stronger than expected.  The U.S. consumer closed out the second quarter on the weak side, with retail sales unchanged for the month and up only 2.3% versus a year ago.  However, prior months were revised higher and some of the softness in June itself was due to a 2.3% drop at auto dealers, likely stemming from cyberattacks that hit dealerships and which should help boost “pent-up” sales in July.  Excluding autos, sales rose 0.4% in June.  Looking at the details of the report, ten out of thirteen major categories rose in June, led by a 1.9% jump in sales at nonstore retailers (think internet and mail-order).  That was partially offset by a pullback in sales at gas stations as gasoline prices fell.  Stripping out gas along with the often-volatile categories for autos and building materials, “core” sales rose 0.7% in June and were up a robust 1.2% when including revisions.  Core sales – which are crucial for estimating GDP – were up at a 3.4% annualized rate in the second quarter versus the Q1 average, much better than the 0.7% annualized pace in the first quarter.  Meanwhile, sales at restaurants and bars – the only glimpse we get at services in the retail sales report – rose 0.3% in June while previous months activity were revised notably higher.  The initial 0.4% decline for that category in May was revised to a 0.4% gain (and prior months were revised higher as well).  Factoring in revisions, these sales were up 1.3% in June.  In the last twelve months, overall sales are up 2.3%, which has not kept up with inflation; “real” (inflation-adjusted) retail sales are down 0.9% in the last year and have remained stagnant for three years since peaking in April 2021.  This is consistent with our view of a slowing US economy as the lagged impacts from the drop in the M2 measure of the money supply from early 2022 through late 2023 take effect.  In other news this week, the Empire State Index, a measure of New York factory sentiment, declined to -6.6 in July from -6.0 in June.  On the trade front, import prices were unchanged in June while export prices declined 0.5%.  In the past year, import prices up 1.6% while export prices are up 0.7%.

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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.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications:   Following a breather in May, producer prices were back on the rise in June, cutting a contrast to the consumer price index report out yesterday.  Producer prices rose 0.2% in June, are up 2.6% in the past year (the highest twelve month reading since early 2023), and the pace of producer price inflation has accelerated since the start of the year, up at a 3.2% annualized rate over the past six months.  The June rise came despite a 2.6% decline in energy prices in June, and a 0.3% drop in food prices.  Stripping out these typically volatile food and energy components shows “core” prices jumped 0.4% in June and are up 3.0% in the past year.  That also represents the highest twelve month increase in more than a year, and a clear shift from the moderation in producer price inflation in 2022 and 2023.  Year-ago comparisons have been moving higher each and every month so far this year, which may serve to give the Fed some pause as they consider the start to rate cuts.  Diving into the details of today’s report shows services prices lead the index higher, rising 0.6% in June and up 3.5% in the past year.  The June increase was almost entirely attributable to a 1.9% jump in margins received by wholesalers.  Goods prices declined in June, led by the aforementioned drop in energy and food prices.  The direction of inflation moving forward is very likely to continue being dictated by the services side of the economy, which suffered heavily during the COVID shutdowns but has since returned to the forefront in consumer demand.  Further back in the supply chain, prices in June fell 0.2% for intermediate demand processed goods but rose 1.4% for unprocessed goods. We do anticipate easing in inflation will come should the Fed have the patience to let tighter monetary policy do its work, and weakening economic data show higher rates and the delayed impact of the decline in the M2 supply starting to bite. But inflation risks an eventual re-acceleration should the Fed panic and ease policy too quickly at signs of economic trouble.

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