Implications: Following nearly three years of contraction, factory activity accelerated unexpectedly to the fastest pace since 2022.  This marks the first time the ISM Manufacturing Index has been in expansion territory since it briefly rose above 50 last January and February. One month does not make a trend, but it is a welcome sign for an industry that has faced an army of headwinds in recent years.  Looking at the details, growth was split, with nine out of the eighteen major manufacturing categories reporting growth in January, while eight reported contraction, and one reported no change.  All major measures of activity rose in January, led by a nearly ten percentage-point increase in the new orders index to 57.1.  You wouldn’t know that new orders grew at the fastest pace in nearly four years based on the survey comments, however, which were chock-full of complaints about tariffs and criticism of the Trump Administration.  It’s important to remember that order books were already weak heading into last year.  Manufacturers had to rely on their order backlogs to keep production going: the order backlog index was in contraction territory for 39 consecutive months, but that streak ended in January, with the index rising to 51.6.  Improving demand was not enough to meaningfully change hiring efforts. The employment index rose to 48.1 in January from 44.8, the highest level in a year – but remains below 50, signaling contraction, now for the 28th consecutive month.  On the pricing front, inflation pressures remain, with the prices index increasing to 59.0 after holding steady at 58.5 in the prior two months. While the index remains elevated relative to historical norms, it is well below the recent peak of 69.8 last April and far below levels seen during the post-COVID inflation surge.  Taken altogether, it remains to be seen whether this report marks the start of sustained growth for the manufacturing industry.  Given last year’s false start, caution is warranted.

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President Trump finally made his pick for Fed Chair and it is Kevin Warsh.  A Wall Street Journal editorial said Warsh has been “the leading voice in public life for reforming the Fed.”  Apparently, the WSJ ignores First Trust, because we have been more than vocal, for more than a decade, about Quantitative Easing, abundant reserves, mission creep, and the fact that the Fed is now losing money every day.

By contrast, Warsh was a Fed Governor in 2008 and voted to start Quantitative Easing.  He later changed his views.  The question is whether he can alter the course of the Fed without getting on the wrong side of President Trump, who wants much lower interest rates and an easier monetary policy.

But to discuss this fully we need to back up a bit.  As most of our readers know, we believe support for the current system of QE and abundant reserves is built on a myth.  QE did not save the economy in the Great Financial Crisis.  QE started in September 2008, but the S&P 500 fell another 40% between then and March 2009.  It was the end of mark-to-market accounting that marked the end of the crisis.

Warsh, technically, supported the very early use of QE (when he voted for it), but criticized its continued use after 2011 and again during COVID…because that ended up creating the first major surge in inflation in 40 years.

This is unfortunate.  The entire experiment in monetary policy needs to end.  QE and abundant reserves have made the world less stable, not more.  But, like so many things in Washington DC, admitting that an entire policy experiment was a mistake is virtually impossible for those who supported it.  To do a 180 on a policy you supported is a sign of weakness.

Let’s list some of the many problems QE has created.  

1) A 40-year high in inflation and more inequality; tripling the money supply in eighteen years created a huge gap between those who owned assets and those who didn’t.  

2) Overreaching bank regulation.  

3) The financing of huge growth in government spending at artificially low interest rates.  

4) Losses on the Fed’s balance sheet and at banks which total over $1.5 trillion, at least 3-times bigger than the original subprime loan losses that led to QE.  

5) Annual losses from operations because the Fed is paying private banks to hold reserves, boosting the federal deficit.

Most sober observers think the Fed ought to shrink its balance sheet.  Kevin Warsh is apparently one of them.  However, policy makers and many market participants are worried that shrinking the Fed’s balance sheet and pushing those bonds into the private sector will lead to higher interest rates and market destabilization.  We would argue that not doing this will lead to even less stability in markets over time.

In 2011, Kevin Warsh wrote: “The path to prosperity requires taking the long road. It requires policy reforms that make the economy less reliant on the preferences of government and more responsive to the market.  That means prioritizing long-term growth over fleeting market stability…temporary stimulus and market manipulation.”

Long-term prosperity cannot be created by running the printing press.  That’s QE.  It should have never been instituted; it is supported by a myth.  It did not save the economy in 2008/09.

In the near term, we expect Powell will keep rate cuts on pause through his departure in May, but that Warsh will restart rate cuts when he takes over.  Warsh has sounded hawkish at times in the past, but that was back when most Republicans liked hawkish rhetoric, so it might have been part of his long campaign for the Fed job.    

We would like to see Warsh quickly shift the Fed against abundant reserves and QE as well as against paying banks interest on reserves.  Unfortunately, investors should expect any moves to unwind these policies will arrive gradually.  But at least Warsh will put those changes on the table.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications: The key to producer prices is to watch the trend, not one-off volatile readings. Producer prices ended 2025 by rising 0.5% in December, despite falling prices from the typically volatile food and energy categories.  But even with the outsized monthly reading, producer prices rose 3.0% in the twelve months ending December, which is an improvement from the 3.5% inflation of 2024.  A look at the details shows the December jump was concentrated and unlikely to continue in the months ahead. Over forty percent of the increase came from a rise in margins for machinery and equipment wholesaling, which rose 4.5%. As a result, prices for the broader services category rose 0.7% in December and ended the year up 3.2%.  Many likely assumed it would be goods prices that would lead inflation higher in 2025, given the higher tariff rates implemented under President Trump, but goods prices were unchanged in December and rose a more modest 2.5% in 2025.  It should be noted the December goods reading was muted by the abovementioned declining prices for energy (-1.4%) and food (-0.3%).   “Core” producer prices – which excludes those typically volatile categories — rose 0.7% in December, the second largest month increase since mid-2022.  We don’t expect the wholesale margins that pushed December producer prices higher will sustain in the months ahead.  In fact, following each of the four prior times in 2025 where margins rose by more than 1.0% in a month (this too is a volatile category), it was followed by a decline in the month that followed.  Again, watch the trend, not one-off readings. Sustained movements in overall inflation are led by the money supply, which is up only 3.0% since April 2022.  Volatility may continue month-to-month, but we expect this monetary tightness will keep inflation relatively subdued, leaving room for rate cuts to continue at some point later in 2026, most likely after Powell is replaced. President Trump announced this morning he intends to nominate former Fed Governor Kevin Warsh.  In other news this morning, the Chicago Purchasing Managers Index (PMI) – where readings above 50 signal growth – surged to 54.0 in January from 42.7 in December, signaling a notable pickup in activity.

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Each year, the U.S. Census Bureau estimates population changes resulting from births, deaths, and migration – both domestic and international. In this week’s Three on Thursday, we narrow the focus to solely domestic net migration between states, highlighting which states are attracting residents – and which are seeing people leave. To put today’s migration patterns into clearer context, click the link below.

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Implications: After narrowing sharply and unexpectedly in October, the trade deficit widened back significantly in November, coming in at $56.8 billion. The increase in the deficit for the month was due to a decline in exports, which fell $10.9 billion, on top of a large increase in imports, which rose $16.8 billion. We like to focus on the total volume of trade, imports plus exports, as it shows the extent of business and consumer interaction across the US border. That measure rose by $5.9 billion in November, is up 1.5% in the past year, but is down 8.9% from the peak hit just earlier last year in March 2025 when many US importers were front-running tariffs to be imposed in April.  Are the Trump tariffs revitalizing US manufacturing?  Employment growth has slowed, particularly in goods-producing industries. For a drop in imports to translate into a lasting economic win, it needs to be accompanied by a clear rebound in U.S. manufacturing and investment—and so far, that resurgence remains tentative. Meanwhile, the GDP math related to the trade deficit suggests that with October and November numbers in on net more of what we purchased overall was made domestically, meaning faster real GDP growth.  At the same time, the landscape of global trade continues to evolve. China, once the dominant exporter to the U.S., has slipped to a distant third behind Mexico and Canada, with exports to the US down 28.4% year-to-date through November versus the same period 2024. And in today’s report, the dollar value of U.S. petroleum exports once again exceeded imports, marking the 45th consecutive month of America being a net exporter of petroleum products. Petroleum exports were more than 44% higher than petroleum imports in November, a new record high. In other news today, initial jobless claims declined 1,000 last week to 209,000, while continuing claims fell 38,000 to 1.827 million.  In other recent news, the M2 measure of the money supply grew 0.4% in December and is up 4.6% from a year ago – still below its historical growth rate of about 6%.  On the manufacturing front, the Richmond Fed index, a measure of mid-Atlantic factory activity, rose slightly to -6 in January from -7 in December.  Finally, in recent housing news, the FHFA index rose 0.6% in November and is up 1.9% in the past year, while the national Case-Shiller index rose 0.4% in November and is up 1.4% from a year ago.  Expect only modest gains in home prices to continue given a deceleration in rents, which means potential homebuyers have less motivation to buy.

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The Federal Reserve held rates unchanged at the first meeting of 2026, while it waits to see what direction inflation, employment, and other policies take in the months ahead.

Starting with the Fed statement, the most significant language changes suggest stronger economic fundamentals.  Economic growth was categorized as “solid,” an upgrade from the prior characterization of “moderate.”  The unemployment rate has “shown some signs of stabilization” (the last Fed statement noted the unemployment had edged up over the prior months).  On the inflation front, comments that inflation had moved up since earlier in the year were struck from today’s statement and now simply reads that inflation “remains somewhat elevated.”  

Notably, both Christopher Waller and Stephen Miran voted against today’s decision to keep rates unchanged, preferring to continue the rate cut process with a further 0.25% cut, a hint of what the president would like to see the Fed do once he’s replaced Powell later this year.  

Moving to the press conference, reporters tried early and often to get Powell to speak out on political matters.  From the Supreme Cout case surrounding Fed Governor Lisa Cook, the looming Supreme Court ruling on the legality of existing tariff measures, to Trump’s plans to replace Powell when his term ends in May, these questions were quite rightly rejected with no comment. We wish we could say that the Fed’s track record of staying out of politics is as strong as Powell’s avoidance today, but that’s a story for another day.  

Once it became clear that political questions wouldn’t generate a headline, the conversation shifted to the question on so many minds: What’s next?  The FOMC believes that their current stance is roughly neutral – or at least not restrictive at current levels – and therefore they have the time and capacity to wait and see how things evolve. Yet, there remains tension between inflation that’s still too high and a job market showing a slow pace of job gains.  We would add that what job growth has occurred has been concentrated in areas like health care and social assistance which are heavily government subsidized. 

It’s clear that inflation is higher on the priority list for many voters, so the question was asked, why isn’t the Fed placing inflation at the forefront?  Put simply, inflation has seen little shift in either direction over the last year, but the Fed believes that has been in no small part due to tariff impacts that are likely to ease in 2026.  By their estimates, inflation beyond tariffs looks to be running in the low 2% range, roughly in-line with their long-term goals.  As a result, they don’t want to act to address an area that looks likely to resolve itself in due time.

Finally, when asked if the current economic environment and the AI boom remind Powell of the late 1990s, Powell said the current environment doesn’t rise to the irrational exuberance levels Greenspan once heralded. It remains to be seen how today’s AI investment will translate to productivity growth in the years ahead. We are hopeful, but cautious.  Models are as good as their inputs. Garbage in, garbage out.  And if there is one thing we learned repeatedly during the COVID years, it’s that official “knowledge” quite often proves false once tested with time and more data. 

The next Fed meeting will take place mid-March, and will be accompanied by updated Fed forecasts.  We don’t anticipate a hike at that meeting, but we will watch the data in the interim for signs that the balance of risk has shifted.  There is a good chance that little happens on the rate front between now and the end of Powell’s term, but there could be a substantive shift in the tone coming from the Fed with the changing of the guard.  From rates, to reserves, to potential changes to the regional Fed bank system itself, 2026 could yet prove a boisterous year for Fed watchers. We, meanwhile, will be keeping our eyes on what it all means for the M2 money supply.    

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications:  Durable goods orders showed strength in November after a brief pare back in October, rising 5.3% – the most in six months. While the gain in new orders was largely due to a 97.6% increase in volatile commercial aircraft orders, a look at the details still reveals promising signs of activity in the fourth quarter.  Transportation is a notoriously volatile category month-to-month, so we prefer to focus on orders excluding transportation for a better check on the broader economy. Those orders rose 0.5% in November, led by electrical equipment (+1.7%), fabricated metal products (+1.0%), and machinery (+0.5%). The only major category which did not increase in November was primary metals (0.0%), only the third month in the past year the category did not rise. Note that both electrical equipment and machinery have seen unusually strong readings over the past year, with each up in at least nine out of the past twelve months.  Particularly, machinery is up at a 10.9% annualized rate in the past six months, the largest gain for any six-month period since 2021. These elevated new orders should translate into shipments in the months ahead. Speaking of shipments, the most important number in today’s release, core shipments – a key input for business investment in the calculation of GDP – rose 0.4% in November following strong gains in September and October.  If unchanged in December, these shipments would be up at a 7.5% annualized rate in Q4 versus the Q3 average.  Finally in other recent manufacturing news, the Kansas City Fed Manufacturing Index, a measure of factory sentiment in that region, remained unchanged at 0 in January.

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The Fed meets on Wednesday to discuss the direction of monetary policy.  With the futures market pricing the odds of “no change in rates” at 97.2%, no one should expect a rate cut at this meeting…or, we think, anytime soon.

Some, including the Trump Administration, might complain about steady short-term interest rates and say Fed Chief Jerome Powell is playing politics.  The claim about playing politics may be true but for now, Powell has the data on his side.  The economy looks solid and inflation remains stubbornly higher than the Fed’s 2% target.

Real GDP grew at a rapid 4.4% annual rate in the third quarter, the fastest quarterly pace in two years.  We like to follow other key measures of economic activity and although they didn’t grow as rapidly, they don’t signal a problem with economic growth, either.

“Core GDP,” which includes consumer spending, business fixed investment, and home building, while excluding the more volatile categories like government purchases, inventories, and trade, grew at a respectable 2.9% annual rate in Q3.  In the meantime, Real Gross Domestic Income, an alternative to Real GDP that is just as accurate over time, rose at a 2.4% rate in Q3.  Not great, but not bad either.  (Remember, the Federal Reserve thinks the long-term growth rate of the economy should average 1.8%, so even 2.4% is faster than that long-term average.)

More impressively, it looks like economic growth in the fourth quarter could come in even faster.  At present, the Atlanta Fed’s GDP Now model suggests the economy grew at a 5.4% annual rate in the fourth quarter.  Yes, much of this is related to a very favorable international trade report for October, which might reverse in November (new data to be released Thursday).  But even if we exclude that by looking at Core GDP for Q4, the economy appears to have grown at about a 2.7% rate.  Not bad.  

The Fed is also looking at the labor market.  While not as strong as the overall economy, the reports there are not showing clear stress, either.  The unemployment rate finished 2025 at 4.4% versus 4.1% a year ago, but private-sector payroll growth continues, in spite of a big drop in net immigration into the US.  Yes, growth in private sector payrolls has been narrow and mostly confined to health care and social assistance, but we don’t think the Fed is focused on this issue for now.  More importantly, the household survey, which contacts people directly rather than surveying employers, shows jobs up 2.4 million in the past twelve months.

Nor is inflation signaling a need for rate cuts.  The Consumer Price Index rose 2.7% in 2025 (December/ December), with core prices, which exclude food and energy, up 2.6%.  And, just released with the GDP data, the GDP Deflator was up at a 3.8% annual rate in the third quarter.  

There are reasons to believe inflation may decline in the next several months.  One key reason is that the M2 measure of the money supply is up only 4.3% in the past year, slower than the pre-COVID trend of about 6.0% per year, which coincided with an average annual CPI inflation rate of less than 2.0%.  As Milton Friedman taught us decades ago, inflation is always and everywhere a monetary phenomenon.

In addition, the way the government calculates the CPI may also lead to a drop in measured inflation.  Zillow’s observed rent index tends to lead the CPI’s measure by about one year and Zillow’s measure of rent decelerated in 2025, suggesting the CPI’s measure of rents will decelerate this year.  That’s a big deal because rent of shelter is about 35% of the overall CPI.  This is also consistent with stricter enforcement of immigration law, right or wrong, putting downward pressure on rents nationwide.

Put it all together and we have a Fed that until Powell departs in May is not only politically inclined to reject rate cuts, but at least for the time being has the economic data to back up its case.  If the Trump team really wants an easier monetary policy, it could drain the Treasury General Account, which currently holds almost $900 billion at the Fed.  By spending that money rather than hoarding it and issuing more debt, it could quickly boost M2 by about 4%.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications:  Consumers were spending at a healthy clip as they kicked off the 2025 holiday season.  Starting with income, private-sector wages and salaries led the way rising 0.4% in November following a 0.5% increase in October.  Government transfer payments increased 0.2% in November and 0.4% in October.  This is a welcome shift from the trend that started in early 2024 where government transfer payments became an increasing share of consumers’ monthly spending power.  Government transfer payments are still up a massive 8.8% in the past year while private sector wages are up 3.9%, but it appears the tides may be beginning to turn. We hope to see private earnings continue to rise at a faster pace than government transfers – which are not a reliable (or desirable) long-term source of income – and will be watching this data closely in the year ahead.  On the spending front, personal consumption rose 0.5% in November.  Goods spending rose 0.7%, led by recreational goods & vehicles as well as footwear and apparel. Services spending increased 0.4% in November, with outlays on financial services, health care, and housing rising the most.  Moving over to inflation, PCE prices, the Fed’s preferred inflation metric, rose 0.2% in November while the year-ago reading rose to 2.8% from to 2.7%.  That 2.8% pace in the past twelve months is up slightly from the 2.6% rate for the twelve-months ending November of 2024, but it’s important to note that inflation readings between May and November of 2024 were relatively subdued before rising at an above average rate to start 2025.  This will be worth keeping an eye on in the months to come as continued monthly readings in the 0.2%-0.3% range would result in the year-over-year reading trending back down toward the 2.0% target.  Pair this with signs from the housing market that rents have subdued (housing is the single largest component of PCE prices), while M2 growth continues to run below the historical 6% rate, and we believe inflation is likely to decelerate in the year ahead.  In other recent news, construction spending rose 0.5% in October, with residential construction leading the way, up 1.3% following a 1.4% decline in September.  Staying on the housing front, pending home sales, which are contracts on existing homes, plunged 9.3% in December – the largest monthly drop since April 2020 - after a 3.3% gain in November, signaling that existing home sales (counted at closing) likely declined in January.

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In 2022, global population surpassed eight billion people for the first time, marking an eightfold increase since 1800. While global population is still growing in absolute numbers, population growth rates peaked decades ago. What lies ahead? For more insight into global population trends, click the link below.

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