Implications:  We hope you are having a happy holiday season; consumers certainly are! Strong income gains and healthy spending continued in November, while headline inflation took a breather.  Personal income rose 0.3% in November (and a more robust 0.5% when including upward revisions to prior months) and is up 5.3% in the past year.  Private-sector wages and salaries represented the bulk of income gains in November, up 0.6% on the month and up 5.7% in the past year.  That said, government activity continues to run hot as well, as government pay rose 0.5% in November and is up 6.4% in the past year, hovering near the largest twelve-month increase in decades. At the same time, government benefit payments to individuals are up 8.6% and are accelerating in the past year, the largest 12-month increase (excluding the COVID stimulus period) in more than a decade.  We don’t think the growth in government pay – or massive government deficit spending – is either sustainable or good for the US economy, which is why we’re also hoping recent budget-related events in DC represent a shift in thinking on the growth of government.  On the spending side, consumption rose 0.4% in November, led by outlays on goods which increased 0.8% and are up 3.0% in the past year.  Spending on services rose 0.2% in November and up a strong 6.6% from a year ago.  Arguably the best news for the consumer in November is that high inflation took the holidays off.  PCE prices, the Fed’s preferred measure of inflation, rose 0.1% in November, so even when adjusting for inflation, consumption rose a comfortable 0.3%.  PCE prices are up 2.4% in the past year, compared to a 2.7% increase in the year ending in November 2023.  “Core” prices, which exclude the ever-volatile food and energy categories, also rose 0.1% in November and are up 2.8% versus a year ago, an improvement from the 3.2% reading for the twelve months ending November 2023.  These numbers will be tracked closely by Fed policymakers in 2025, as their forecasts from Wednesday’s meeting showed they expect headline inflation to end next year slightly higher (2.5%) than it is today.  While the Fed cut once again at their final meeting of 2024, they acknowledged that the path forward is more uncertain, and cuts are likely to move much more slowly in 2025.  Risks remain that an overly aggressive path of cuts could also bring with it a pickup in the M2 measure of money, which would lead to a return of inflation pressure. We wish the Fed would acknowledge past faults and prioritize the money supply in their inflation analysis moving forward, but that would take a Christmas miracle.

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With Bitcoin recently surpassing $100,000 per coin, this week’s “Three on Thursday” explores the cryptocurrency in depth. Bitcoin’s appeal lies in its secure, borderless, and inflation-resistant nature, offering an alternative to traditional financial systems.

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Implications:  Existing home sales continued to show signs of life in November, rising for the second month in a row. While the headline gain of 4.8% is positive news, sales activity is subdued.  The 4.150 million pace of November is well below the roughly 5.250 million annual pace that existed pre-COVID, let alone the 6.500 million pace during COVID.  One problem recently is that since the Federal Reserve began cutting interest rates in September, 30-year fixed mortgage rates have risen back above 7%. So at least so far, the widely anticipated shot in the arm to the housing market from improved affordability hasn’t happened and most buyers continue to sit on the fence. Meanwhile, home prices are rising again with the median price of an existing home up 4.7% from a year ago. Speaking of price, it looks like the housing market has bifurcated along these lines. While the sales of homes worth $500,000 and above are up at double-digit percent rates in the past year, sales for homes below this threshold have continued to struggle. On a positive note 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, it also suggests that inventory at the lower end of the price spectrum has all but disappeared after the inflation of the past few years. Moreover, 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 17.7% 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) to 3.8 in November, a considerable improvement versus the past few years, but 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.  On the manufacturing front, the Philadelphia Fed Index, a measure of factory sentiment in that region, fell to -16.4 in December from -5.5 in November.  Meanwhile, the Kansas City Fed Manufacturing Index, the counterpart in that region, declined to -4 in December from -2 in November.

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Implications:   The final reading for real GDP growth in the third quarter was revised upward from last month’s estimate, coming in at a 3.1% annual rate, and, the underlying components showed a slightly stronger mix. Upward revisions in consumer spending (primarily services), net exports, business investment (equipment & software), home building, and government purchases more than offset a downward revision to inventories. For a more accurate measure of sustainable growth, we focus on "core" GDP, which includes consumer spending, business fixed investment, and home building, but excludes the more volatile categories like government purchases, inventories, and international trade. "Core" GDP grew at a 3.4% annual rate in Q3, above the prior estimate of 3.2%. However, the second look at economy-wide corporate profits for Q3 revealed a downward revision, with profits declining 0.4% from Q2 (compared to the -0.3% initially reported) but still up 6.0% year-over-year.  Since Federal Reserve profits are included in this data – and the Fed has been posting substantial losses – we focus on corporate profits excluding the Fed, which are up 4.7% year-over-year.  Using pre-tax profits, our Capitalized Profits Model suggests stocks remain overvalued.  We also received a second look at Q3 Real Gross Domestic Income (GDI), an alternative measure of economic activity.  Real GDI was revised slightly lower to a 2.1% annual growth rate but is up 3.0% from a year ago.  GDP inflation was unrevised at 1.9% annually in Q3, and GDP prices are up 2.2% over the past year.  Meanwhile, nominal GDP (real growth plus inflation) increased at a 5.0% annual rate in Q3 and is up the same year-over-year. A 5.0% trend growth rate in nominal GDP suggests the Fed should be reluctant for at least the near future.  On the labor front this morning, initial jobless claims declined 22,000 last week to 220,000. Meanwhile, continuing claims declined 5,000 to 1.874 million.  These figures are consistent with continued job growth in December, but at a slower pace than earlier this year.

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The Federal Reserve cut interest rates for the third time this year but signaled the path forward will likely be more gradual – and less certain – than previously forecast.  The Fed cut by a quarter percentage point today, following on the half point cut in September and a quarter in November.

Today’s statement saw very few alterations from the November meeting.  Language was added that the Fed will consider “the extent and timing” of additional adjustments to interest rates, which Powell later clarified was meant to signal a slower pace of cuts moving forward.  It is also worth noting that Cleveland Fed President Beth Hammack voted against today’s rate cut, preferring instead to keep rates unchanged. 

The Fed also released an updated Survey of Economic Projections (the “Dot Plots”) showing their expectations on GDP, employment, inflation, and rates in the years ahead.  Fed members paired back cut expectations in 2025, from four cuts forecast when projections were last released in September, to a more modest two cuts for 2025 projected today.

Justification for the slower pace of easing comes in the form of higher inflation expectations for 2025, with PCE prices now forecast to end this year at 2.4% and then rise in 2025 to 2.5% (back in September, the Fed forecast inflation to decline to 2.1% in 2025).  Along with higher inflation expectations, the Fed is forecasting 2025 to see a slightly lower unemployment rate (now 4.3% from 4.4% in September) and slightly faster inflation-adjusted GDP growth (up to 2.1% from 2.0%).

Given the Fed has prioritized headline PCE prices as the best measure of inflation experienced by consumers – and with their forecasts today that these prices will rise, not fall, in the year ahead – it begs the question why the Fed believes that further rate cuts are warranted in 2025.  The cooling labor market has brought the employment side of the Fed dual mandate into balance with inflation risks, and the Fed may be forced to choose if rising inflation trumps weaker jobs growth if (or when) push comes to shove.

During the press conference Powell was once again peppered with questions around how the election results and potential policy changes ahead have impacted their forecasts. In short, Powell stated that the election results have little impact on their short-term views.  The Fed does not know what – or when – policy changes will be implemented under the new administration and has no plans to speculate.

What Powell didn’t get much of in today’s press conference was real pushback on the hard questions. Why has the Fed abandoned the “SuperCore” inflation metric they prioritized two years ago? Why has the Fed continued to ignore the money supply in their analysis when it outperformed virtually any other measure in predicting the inflation the Fed said would never occur? How is the Fed running operating losses of more than $100 billion per year and still paying for non-monetary research?  We didn’t expect any reporters to step up to the plate and press Powell, but these are questions that need answers.  

The stage is set for an epic battle in Washington over the year ahead. Tax cuts and deregulation stand to boost businesses, while a clamping down on government excess could slow the outsized deficit spending that has propped up economic growth. What will we be watching?  If M2 growth remains modest, both inflation and economic growth will slow, but the Fed will have room to continue cuts. If, however, rate cuts lead to a rapid rise in M2 growth, the Fed has shown an active neglect of the warning signs that would have preempted this inflation debacle to begin with. 

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications:  November was another tough month for homebuilders, as housing starts missed consensus expectations and declined 1.8%, falling to a four-month low.  However, the details for November were not quite as bad as the headline.  The decline in starts in November was entirely due to a 23.2% drop in the volatile multi-family category, which more than offset a 6.4% rebound in single-family construction as hurricane weather delayed activity in the South and Northeast regions the previous month. Another silver lining is that permits for new builds jumped 6.1% in November to a nine-month high, although that was driven by a 19.0% jump in the multi-family category.  Still, building permits and housing starts appear to be stuck in low-gear, down 0.2% and 14.6%, respectively, from a year ago, and sit at roughly the same levels as 2019.  The same cannot be said for completions.  Despite a third straight monthly decline, completions are up 9.2% in the past year and were at a faster pace in November than any month from 2021-2023.  With strong completion activity and tepid growth in starts, the total number of homes under construction continues to fall, now down 14.6% since the start of 2024.  That type of decline is usually associated with a housing bust or recession.  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. 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.  Notably, while mortgage rates were trending lower leading up to the first rate cut announcement from the Federal Reserve in September, these rates are up roughly 50bps since then. That said, there are some tailwinds for housing construction, as well.  Many owners of existing homes are hesitant to sell and give up their fixed sub-3% mortgage rates, so prospective buyers will often 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.  In other recent housing news, the NAHB Housing Index (a measure of homebuilder sentiment) remained at 46 in December.  A reading below 50 signals a greater number of builders view conditions as poor versus good.

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Implications:  Industrial production fell for a third consecutive month in November, coming in weaker than expected. It was widely anticipated that the resolution of the Boeing strike and the end of the lingering effects of recent hurricanes would be enough to spark a rebound.  That said, the details in today’s report painted a mixed assessment on the manufacturing sector.  Overall, manufacturing output rose 0.2%.  However, production in the volatile auto sector was entirely responsible, with activity jumping 3.5%. Meanwhile non-auto manufacturing (which we think of as a “core” version of industrial production) posted a modest decline of 0.1% in November. Notably, manufacturing activity in aerospace (the sector directly affected by the end of the strikes) continued to fall in November, posting a decline of 2.6%. The only bright spot in this “core” measure came from production in high-tech equipment which rose 0.4% in November, likely the result of investment in AI as well as the reshoring of semiconductor production.  High-tech manufacturing is up 7.4% in the past year, the fastest for any major category.  The mining sector was also weak in November, falling 0.9%.  Declines in oil and gas extraction, the drilling of new wells, and the extraction of other minerals and metals all contributed.  Look for gains in that sector in 2025 as the incoming Trump Administration takes a more aggressive stance with permitting.  Finally, the utilities sector (which is volatile and largely dependent on weather) also posted a decline in November, falling 1.4%. In other recent manufacturing news, the Empire State Index, which measures manufacturing sentiment in the New York region, dropped to +0.2 in December from +31.2 in November.

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Implications:   Consumers started off the holiday shopping season strong as retail sales narrowly beat expectations in November, rising 0.7%.  Discounted deals during this year’s Black Friday and Cyber Monday holidays were enough to lure US consumers into spending record amounts (although inflation, discussed below, makes spending look artificially strong).  The two categories that reaped the most benefit and responsible for the majority of November’s gain were autos and nonstore retailers (think internet and mail-order businesses) which jumped 2.6% and 1.8%, respectively, and both sit at all-time highs.  The surge in autos and nonstore retailers masked split spending elsewhere.  Looking at the details, seven out of thirteen major sales categories rose in November while six declined.  We like to follow “core” sales, which strips out the often-volatile categories for autos, building materials, and gas.   That measure rose 0.2% in November and, if unchanged in December, will be up at a respectable 4.2% annual rate in the fourth quarter versus the Q3 average.  Within the core sales grouping, sales at restaurants and bars dropped 0.4%, the first decline since March.  Restaurant and bar sales are up 1.9% in the past year, a notable slowdown from the 11.1% increase in the year ending in November 2023.  We will be watching this category closely since it is the only glimpse we get at services in the retail sales report, which suffered heavily during the COVID years but have since returned to the forefront of the US consumer.  As a whole, retail sales are up 3.8% on a year-to-year basis.  “Real” inflation-adjusted retail sales are up 1.0% in the past year but still down from the peak in early 2021.  This highlights the ugly ramifications of inflation: consumers are paying higher prices today but taking home fewer goods than they were three years ago.  And while the Fed looks set to cut interest rates by another quarter percentage point at the conclusion of the meeting tomorrow, it is not at all clear that inflation problems are behind us.  We hope they have the resolve to stomp out the embers of inflation even if economic troubles come.  In other recent news, import prices rose 0.1% in November while export prices were unchanged.  In the past year, import prices are up 1.3% while export prices are up 0.8%.

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The most fun anyone has had at a Jerome Powell presser was when a reporter asked about President Trump removing Powell from his job.  Otherwise, almost all the questions are about when and how much the federal funds rate will be cut.

The reason we bring this up is that there are only certain reporters allowed in the Fed’s press briefing, and, other than hearings on Capitol Hill, it’s the only chance the nation has to ask questions.  If a member of the Press Corp asked about New Jersey drones, they might not get invited back.  But it seems to us that there are very obvious and important questions that never get asked.  Who will be the Peter Doocy of the Fed Press Corp?

So, just in case there is a member of the press who is willing to push the envelope here are a few questions we suggest.

First, about two years ago the Fed drew attention to something called “SuperCore” inflation, which excludes all goods, food, energy, and housing rents.  At the time, SuperCore inflation was running less hot than overall inflation.  Today, the CPI version of SuperCore is up 4.3% in the past year and is running hotter than it was a year ago.  The PCE version is likely to be up at least 3.5% in the year ending in November, well above the Fed’s 2.0% inflation target.  And yet the Fed now seems to ignore SuperCore.  What changed?  Did the Fed have second thoughts about the usefulness of SuperCore?  If so, why did the Fed change its mind?  Or did the Fed stop talking about it because the message from SuperCore is that inflation is nowhere near stabilized?

Second, the M2 measure of the money supply soared more than 40% in the first two years of COVID, and what followed was the highest inflation in four decades.  The M2 money supply then dropped and, initially, inflation dropped fast.  Do you think these were just coincidences, or do you think keeping track of the money supply might actually help the Fed predict future inflation trends?   Do you know of any other measure that did a better job of predicting the COVID-era inflation trends than M2?  If so, why weren’t you using it before the high inflation hit or back when you were claiming inflation was “transitory?”

Third, the Fed has been running operating losses of about $100 billion per year for each of the past two fiscal years.  Those operating losses are covered by the Treasury Department out of general revenue.  And yet Federal Reserve Banks around the country, and perhaps even at the Board of Governors itself, are still paying for and publishing non-monetary research.

For example, the Chicago Federal Reserve Bank is very concerned about childcare and lead water pipes.  There are multiple other government agencies that focus on these issues.  Doesn’t the Fed feel a responsibility, at a time when it’s running huge losses, to at least temporarily stop spending taxpayer money on these activities?  How much of the research in the past two years is on topics outside the Fed’s jurisdiction, which, under law, is supposed to be monetary policy and bank regulation?  What other initiatives outside these key topics are the Fed funding with taxpayer money?  Do you think the Fed itself should be the sole arbiter of what kind of research it pays for?  Is there any dollar limit the Fed should have on research and other spending?

Unfortunately, we doubt anyone in the press will ask Powell these questions.  Maybe the new Department of Government Efficiency (DOGE) will ask.  Somebody needs to.  The Fed’s balance sheet has grown about 7X (700%) since the start of QE in 2008, and it seems that it has done so with very little oversight, from Congress, the White House, or the Press Corp.

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 look at the Federal Reserve’s financials through the third quarter of 2024. 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.

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