How Fast, How High, How Long

First Trust Economic Research Report

Brian S. Wesbury - Chief Economist

Robert Stein - Deputy Chief Economist

November 2, 2022

The Federal Reserve plans to keep raising rates at future meetings, but at a slower pace than it has for the last four meetings. Today the Fed once again voted unanimously to raise rates by three-quarters of a percentage point – 75 basis points (bps) – bringing the target for the federal funds rate to 3.75 – 4.00%, but far more attention is being paid to the path forward from this point. While today’s statement was not accompanied by updated rate forecasts from the Fed (our next look at the dot plots comes in December), it’s clear a shift is on the horizon.

The Fed statement released today included much of the same text seen following their September meeting, with a few key additions. First, the Fed noted it anticipates ongoing hikes will be appropriate until they have reached “a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.” What level will prove sufficiently restrictive? Nobody – including the Fed – knows. Coming into 2022, the Fed thought that cumulative hikes of 75 basis points (bps) would be enough to quell inflation this year. Then in March it became 175 bps, in June it was 325, and as of September it was 425. During the press conference, Powell said the restrictive level now looks even higher.

The second key addition to today’s statement was a sentence that the Fed will take into account the “lags with which monetary policy affects economic activity and inflation.” In other words, the Fed is moving towards a more measured pace of rate hikes while they wait to see how this year’s actions to-date flow through the system.

These changes set up Powell to clarify during the press conference how they are now thinking about where they need to move on rates, which rests on three questions: how fast, how high, and how long? The Fed has moved quickly to raise rates, after clearly starting late. Now the focus is shifting to the other two questions. How high will rates ultimately have to go and how long will the Fed keep rates elevated to bring inflation into check. While the pace of hikes may begin to slow, they are likely to end higher – and remain there for longer – than was previously anticipated. The fight against inflation is far from done. Today’s actions represent a pivot in how they are approaching the fight.

Our biggest concern is that the Fed continues to ignore the M2 measure of the money supply and not one reporter asked a question on the topic. While Powell was questioned on the topic at a recent conference by the Cato Institute, he brushed the idea off and continued to push the same tired model of inflation that has left the Fed well behind the curve and constantly revising forecasts higher.

The bottom line is that it’s good the Fed has prioritized the fight against inflation, but it remains overly optimistic in the effectiveness of its policies to get inflation under control. Follow the growth of M2 – which has thankfully slowed and must remain low for the foreseeable future – for guidance on the path forward from here.

Text of the Federal Reserve's Statement:

Recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures.

Russia's war against Ukraine is causing tremendous human and economic hardship. The war and related events are creating additional upward pressure on inflation and are weighing on global economic activity. The Committee is highly attentive to inflation risks.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 3-3/4 to 4 percent. The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve's Balance Sheet that were issued in May. The Committee is strongly committed to returning inflation to its 2 percent objective.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals. The Committee's assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michael S. Barr; Michelle W. Bowman; Lael Brainard; James Bullard; Susan M. Collins; Lisa D. Cook; Esther L. George; Philip N. Jefferson; Loretta J. Mester; and Christopher J. Waller.

To view this article, click here.

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.

Fed Raises Interest Rates by 75 Basis Points

November 4, 2022

Dear Friends and Clients,

The U.S. Federal Reserve (Fed), in keeping with its aggressive efforts to curtail inflation, announced its fourth consecutive interest rate hike of 75 basis points (bps) at the November Federal Open Market Committee (FOMC) meeting. That brings the cumulative increase year to date to 375 bps and marks the sixth interest rate hike since March 16, when the Fed’s tightening cycle commenced.

“The Fed is expected to continue raising interest rates at least one more time this year, and then one to two more increases next year. During its December FOMC meeting, we expect the Fed to increase the federal funds rate by another 50 basis points, and then two more 25 basis point increases in February and March of 2023,” said Raymond James Chief Economist Eugenio J. Alemán, Ph.D.

As inflation concerns and talk of a recession lingers, there’s some uncertainty in the air. You may have asked yourself: “How will these factors impact my portfolio?” It’s a normal question to pose when the word “recession” is whispered, and market fluctuations are ever present. As your financial advisor, we’re here to help assuage your concerns and work with you through this period.

While what’s transpiring may feel out of the ordinary, we have seen market pullbacks and corrections before. They are necessary to sustain a healthy market.

You’ll likely recall in our previous conversations our emphasis on developing a tailored financial plan that’s focused on long-term financial goals. What’s currently happening illustrates the importance of that approach.

“We encourage investors not to focus on daily headlines and certainly not to make investment decisions based on those headlines,” said Raymond James Chief Investment Officer Larry Adam. Here are some key facts to bear in mind:

  • Markets are cyclical, and long-term returns have been historically positive

  • Missing even a few trading days in an attempt to time the market can significantly impact your returns

  • Temporary pullbacks may present an opportunity to strategically add to your portfolio

As always, we look forward to speaking with you to discuss these matters as well as address any questions or concerns you may have.

Thank you for the trust you place in us.

Sincerely,



Investment advisory services offered through Raymond James Financial Services Advisors, Inc. and Goodrich and Associates, LLC. Goodrich and Associates, LLC is not a registered broker dealer and is independent of Raymond James Financial Services, Inc. All expressions of opinion reflect the judgment of Raymond James’ Chief Economist and are subject to change. There is no assurance the trends mentioned will continue or that the forecasts discussed will be realized. Past performance may not be indicative of future results. Economic and market conditions are subject to change. Investing involves risk, and you may incur a profit or loss regardless of the strategy selected.

Drop in Budget Deficit is a “Sugar High”

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

October 31, 2022

After nearly three years of the economic and financial market distortion due to COVID lockdowns, money printing, and massive government borrowing, some of these distortions are subsiding. For example, the federal budget deficit in FY2021 was $2.78 trillion, but for FY2022 (which ended on 9/30), it fell to $1.375 trillion.

As you would expect, some are treating this as huge progress toward fiscal sanity. But we beg to differ.

First, the budget deficit as a percent of GDP was 5.5% of GDP last year, the eighth largest since 1947.

Second, because of the way government accounting is done, the Biden Administration’s policy to forgive some student loan debt added $426 billion to the deficit and will likely add substantially more as we get details on the proposal to limit future repayments based on income. In other words, policymakers in Washington, DC are still itching to come up with new ways to ramp up spending.

Third, the federal government spent 25.1% of GDP last year. With the exception of the COVID years, FY2022 spending as a share of GDP was the highest for any year since World War II. That’s right, this is even higher than the peak year of the Financial Panic (FY 2009), when spending peaked at 24.3% of GDP. What makes this even more astonishing is that the unemployment rate averaged 3.8% during this past fiscal year, compared to 8.5% in FY 2009.

And this begs the question: With government spending so high, how in the world did the deficit decline so much? The answer: a surge in government revenue. Revenue hit 19.6% of GDP in FY 2022, only surpassed by the last two years of World War II and the year 2000, during the dot-com boom.

Individual income tax receipts soared 29% last year, to an all-time record high, and were $1 trillion above the level of FY2020. What makes this surge in revenue so unique is that in the past 31 months (since March 2020) US workers have worked 31.2 billion fewer hours than they would have if employment would have remained flat at its February 2020 level. That’s a lot of lost production, yet the Federal Government keeps raking in more revenues.

How? Because the massive fiscal and monetary stimulus of 2020-21 was essentially economic morphine that policymakers used to mask (part of) the pain of unprecedented COVID-related shutdowns. That morphine artificially and temporarily boosted economic activity and has now led to the highest inflation in forty years. Nominal wages and profits surged, and so did government revenue. In a sense, the government borrowed from future generations to hand out checks and then taxed its own stimulus back after it circulated in the economy. This “sugar high” can’t and won’t last.

But now, because of high inflation, the government is pulling back on the monetary morphine. Although we don’t think a recession has started yet, we think a recession is on the horizon, which means the fiscal picture in 2023-24 will not be anywhere as good. Look for bigger budget deficits the next few years as the revenue “sugar high” wears off.

The attached information was developed by First Trust, an independent third party. The opinions are of the listed authors at First Trust Advisors L.P, and are independent from and not necessarily those of RJFS or Raymond James.  All investments are subject to risk. There is no guarantee that these statements, opinions, or forecasts provided in the attached article will prove to be correct. Individual investor's results will vary. Past performance does not guarantee future results. Forward looking data is subject to change at any time and there is no assurance that projections will be realized. Any information provided is for informational purposes only and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected.

The Last Hurrah?

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

October 24, 2022

Most investors we talk to think the US is already in a recession or that a recession will start by the end of 2022. We think they’re wrong on both counts.

Yes, we are fully aware that the reports on real GDP growth for the first two quarters of the year were negative. But, as economists, we are also aware that the GDP reports will be revised once a year for the next several years and are confident they will ultimately show positive growth. Why? Because the unemployment rate has dropped, payrolls have grown at a very rapid pace, and industrial production continues to climb.

Don’t get us wrong; we’re not “recession deniers.” We think a recession is coming because monetary policy will have to get tight enough to bring inflation back down and a monetary policy tight enough to do that is also likely to drag the economy into a recession. We’re just not there yet. We expect a recession to start in the second half of 2023, with some risk of it starting in either the first half of 2023 or first half of 2024.

In the meantime, as set out below, our calculations show economic growth at a 3.0% annual rate for the third quarter, which is probably going to be the fastest growth we see for any quarter from now until the next recession is done.

Consumption: “Real” (inflation-adjusted) retail sales outside the auto sector declined at a 1.4% annual rate in Q3 while sales of autos and light trucks slipped at a 0.4% rate. However, it looks like real services, which makes up most of consumer spending, should be up at a solid pace. Putting it all together, we estimate real consumer spending on goods and services, combined, increased at a modest 1.0% rate, adding 0.7 points to the real GDP growth rate (1.0 times the consumption share of GDP, which is 68%, equals 0.7).

Business Investment: We estimate a 5.8% annual growth rate for business equipment investment, a 7.4% gain in intellectual property, and no change in commercial construction. Combined, business investment looks like it grew at a 5.6% rate, which would add 0.7 points to real GDP growth. (5.6 times the 13% business investment share of GDP equals 0.7).

Home Building: Amid higher mortgage rates and buyer skittishness, residential construction looks like it fell at a 16.5% annual rate. A decline at a 16.5% rate would subtract 0.8 points from real GDP growth. (-16.5 times the 5% residential construction share of GDP equals -0.8).

Government: Remember, only direct government purchases of goods and services (not transfer payments like unemployment insurance) count when calculating GDP. We estimate these purchases – which represent a 17% share of GDP – grew at a 0.6% rate in Q3, adding 0.1 point to real GDP growth. (0.6 times the 17% business investment share of GDP equals 0.1).

Trade: Exports remain very close to all-time highs in Q3 while imports have declined sharply, in part a reflection of businesses with too much inventory cutting back on foreign purchases. That means a smaller trade deficit. At present, we’re projecting net exports will add 2.7 points to real GDP growth, although a report on the trade deficit in September, which arrives on Wednesday, may alter that forecast.

Inventories: Inventories look like they grew at a slower pace in the third quarter than they did in Q2, suggesting a drag of about 0.4 points on the growth rate of real GDP. However, just like with trade, a report out Wednesday may alter this forecast.

Add it all up, and we get 3.0% annual real GDP growth for the third quarter. An economic storm is coming. The sun is still shining today, but, with almost all the net growth in Q3 coming from the trade sector, the clouds are forming on the horizon.

The attached information was developed by First Trust, an independent third party. The opinions are of the listed authors at First Trust Advisors L.P, and are independent from and not necessarily those of RJFS or Raymond James. All investments are subject to risk. There is no guarantee that these statements, opinions, or forecasts provided in the attached article will prove to be correct. Individual investor's results will vary. Past performance does not guarantee future results. Forward looking data is subject to change at any time and there is no assurance that projections will be realized. Any information provided is for informational purposes only and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected

Second Thoughts on Bernanke’s Nobel Prize

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

October 17, 2022

The Nobel Prize in Economics was recently awarded to former Federal Reserve Chairman Ben Bernanke, as well as professors Douglas Diamond and Philip Dybvig, for their work on understanding the role banks play in the economy, especially during a financial crisis.

All three of them have done important work that’s worthy of recognition.  Banks are key parts of the economy that, by assessing the creditworthiness of borrowers, help channel the savings of households and companies into productive investment.  Bank failures, in turn, threaten to make it tougher for an economy to direct savings to where they’re most useful.

However, like many recent Nobels this award seems to ratify expansionary government policy.  Bernanke’s approach to the Financial Panic of 2008-09 included a massive bailout of the financial system, monetization of government spending, and a huge expansion in the Federal Reserve’s balance sheet.

The Bernanke approach did not include fixing mark-to-market (MTM) accounting, which was the key ingredient that turned a limited financial fire into a raging inferno that almost burned down the entire US financial system.

To review, in late 2007 the Financial Accounting Standards Board (FASB) forced financial firms to use market prices to value securities, rather than models or cash flow. Within a year, the U.S. was in the middle of the worst financial panic in a hundred years. This was not a coincidence.

On the surface, MTM made sense.  Markets usually provide transparent and verifiable prices, so companies couldn’t just make up numbers.  The problem is that market prices often deviate – sometimes substantially, but always temporarily – from underlying fundamental value.  Since markets are forward looking, MTM forced financial firms to take hits to capital over something that might happen in the future but hadn’t happened yet.  It was like forcing homeowners to come up with more capital as a hurricane approaches because their homes might get destroyed.

This, in turn, created a vicious cycle as capital constraints hurt banks, undermined the economy and drove asset prices lower, and then destroyed more capital.  In 2008, when markets for even prime mortgage-backed securities became illiquid, the financial crisis intensified.

Finally, in March 2009, six months after TARP and QE were put in place, the stock market was still falling.  That’s when Congress (specifically, Barney Frank) started to twist arms, forcing FASB to loosen up its rules and allow cash flow to be used when markets were illiquid.  This seemingly small adjustment did the trick.  Banks were finally able to raise new capital, the stock market surged, and the economy started a long and sustained recovery.  This was no mere coincidence, but Ben Bernanke, as far as we know, has never publicly discussed it.

We find that odd because Bernanke should be familiar with the damage MTM can do.  Bernanke is a student of the Great Depression and Milton Friedman won the Nobel Prize for his work on the Great Depression, as well.  In addition to his focus on the money supply, Friedman also wrote about how a MTM rule in the 1930s caused many banks to fail.  Not coincidently, the Roosevelt Administration suspended MTM in 1938 and, simultaneously, the Depression ended.

We, and others, including Peter Wallison, have written extensively about the economic damage done by the MTM accounting rule…especially to the financial markets.  Yet, the Fed, other government agencies, and academics have ignored it.  Apparently, even if you have solid evidence that TARP and QE really didn’t end the 2008 Panic, you should be ignored.   The only narrative allowed is that free markets caused the crisis and the government saved us. 

And now, Nobel Prize or not, the bill is coming due on the “abundant reserves” monetary model that is the result of Bernanke’s research.  The US has its highest inflation rate in 40 years.  True, this didn’t happen in the aftermath of the 2008-09 crisis, because the M2 measure of money remained more stable.  But government spending surged much more during COVID and Bernanke’s new system monetized it.

Having some insights into the role banks play in an economy is not the same as fully understanding the economy.  And dismissing the role of MTM accounting seems intellectually dishonest.  We have second thoughts about anyone who does.

The attached information was developed by First Trust, an independent third party. The opinions are of the listed authors at First Trust Advisors L.P, and are independent from and not necessarily those of RJFS or Raymond James.  All investments are subject to risk. There is no guarantee that these statements, opinions, or forecasts provided in the attached article will prove to be correct. Individual investor's results will vary. Past performance does not guarantee future results. Forward looking data is subject to change at any time and there is no assurance that projections will be realized. Any information provided is for informational purposes only and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected.

The CPI Is Important, But What Else Are Inflation Watchers Watching?

The Consumer Price Index gets a lot of attention each month, but it’s not the only game in town.

When it comes to measuring inflation, investors and policymakers have a full menu of alphabet-soup metrics to choose from—the CPI, the PPI, the PCE, the GDP Index, and a host of others. But the Consumer Price Index (CPI)1 typically grabs most of the headlines—and for good reason. From determining the size of next year’s Social Security checks to influencing the amount of interest that owners of Treasury Inflation-Protected Securities (TIPS)2 will earn, time and time again, the monthly CPI print has moved markets and dictated the course of US monetary policy. But as a classic lagging indicator, the CPI has often been criticized for reflecting trends that are already out of date; critics also say it uses methodologies that may be prone to error or subtle biases (see page 4 for more on this).

For the average consumer or casual investor, the so-called “headline” CPI number— the figure that also includes volatile food and energy prices—may be sufficiently revelatory. The August report, for example, showed that the annualized rate of inflation stood at 8.3%, slightly lower than July’s 8.5%. While the small statistical retreat was largely attributed to moderating energy costs, analysts zeroed in on underlying month-to-month price increases in the cost of food, new cars, housing, and electricity, and natural gas, which suggested to the Federal Reserve (Fed) and other stakeholders that inflation was (and is) still a thing.3

But many economists, investors, and other serious inflation-watchers, who hope to unearth trends that the CPI may overlook, will often train their focus on alternative inflation measures, which can sometimes provide a broader, more nuanced, view of the direction and timeliness of price movements. Let’s look at some of the more prominent alternative inflation measures.

To read the whole article click on the link below!

https://www.hartfordfunds.com/dam/en/docs/pub/whitepapers/WP708.pdf

Reports: Solid Growth, Persistent Inflation

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

October 10, 2022

Recent economic reports further undermine the politically-motivated argument from earlier this year that the US was already in a recession. They also undercut the Fed’s hopes that inflation will soon subside.

On the job front, nonfarm payrolls rose 263,000 in September while the unemployment rate fell back to 3.5%, tying the lowest level since 1969. Payrolls are up at an average monthly pace of 420,000 so far this year – that isn’t a recession. And data show the share of voluntary job leavers (often called “quitters”) among the unemployed reached 15.9%, the highest since 1990. People don’t quit their jobs unless they have optimism about their job and earning prospects.

Meanwhile, the ISM Services index came in at a robust 56.7 for September. Yes, the ISM Manufacturing index declined to 50.9, but that’s still in expansion territory (north of 50) and the services portion of the economy is much larger than manufacturing. Auto sales remained softer than normal in September, but, at a 13.5 million annual rate, were the fastest since April.

Put it all together, and we are tracking a 3.0% real GDP growth rate in the third quarter. The Atlanta Fed’s GDPNow model is tracking 2.9%, almost exactly the same. Net exports look very good in Q3 and should account for most of the growth. Again, no recession, yet.

At the same time, inflation remains stubbornly high. The consensus forecast for this Thursday’s report on the Consumer Price Index (CPI) is that it grew by a relatively mild 0.2% in September. We would not be surprised by an increase of 0.2% but think the increase is more likely to be 0.3%.

But that’s for September, when oil prices were weaker. For October, the Cleveland Fed’s “inflation nowcast” is tracking an increase of 0.7% in the CPI. The Cleveland Fed also forecasts the “core” CPI, which excludes food and energy, will rise 0.5% in both September and October. In addition, the nowcast suggests PCE inflation will run 6.1% for 2022 (Q4/Q4) compared to the 5.4% the Federal Reserve projected less than three weeks ago.

If the Fed can keep the M2 measure of the money supply growing at the 1.5% annual rate that’s prevailed so far this year, we think inflation will eventually slow down. But that doesn’t mean it’s going to slow down as fast as the Fed thinks. Less than three weeks ago the Fed projected 2.8% PCE inflation in 2023. That seems like a political forecast, not a forecast based on economic reality and models.

Rents make up a large part of consumer inflation measures and still have a very long way to go to catch up to home price appreciation during COVID. They’re an even larger part of “core” inflation measures, which should outstrip broader inflation for the next year or so. Moreover, after falling below $80 a barrel a few weeks ago, West Texas Crude prices are now back above $90. Inflation data is not going to be pretty in the quarters ahead.

The bottom line is that the Fed isn’t going to stop or even slow rate hikes very soon. Expect another hike by three-quarters of a percentage point (75 basis points) in early November, followed by another half percentage point (or more!) in mid-December. Then, in 2023, look for rougher economic waters by year end.

The attached information was developed by First Trust, an independent third party. The opinions are of the listed authors at First Trust Advisors L.P, and are independent from and not necessarily those of RJFS or Raymond James.  All investments are subject to risk. There is no guarantee that these statements, opinions, or forecasts provided in the attached article will prove to be correct. Individual investor's results will vary. Past performance does not guarantee future results. Forward looking data is subject to change at any time and there is no assurance that projections will be realized. Any information provided is for informational purposes only and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected.

No Recession, Yet

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

October 3, 2022

We are not “recession deniers,” we just don’t think one has started yet. The distortions of economic activity from lockdowns, massive deficit spending, and money printing are immense. It’s hard to imagine the US can unwind these policies and not have a recession.

Monetary policy, for example, is going to have to get tight and stay tight to bring down inflation and keep it there, so we don’t get into a stop-and-go cycle of inflation problems like we did back in the 1970s and early 1980s. And a monetary policy that gets tight enough and stays tight enough for long enough to achieve that goal is very likely to cause a recession. We’re just not there yet.

Initial jobless claims totaled only 193,000 in the week ending September 24, extremely low by historical standards, while continuing jobless claims are just 1.347 million. Industrial production is up at a 4.0% annual rate in the first eight months of the year. Gross Domestic Income (GDI) was positive in the first six months of 2022. These are just not recessionary numbers.

Meanwhile, we are projecting a 3.0% annualized growth rate for real GDP in the third quarter. Hurricane Ian should have a temporary negative effect, but it hit so late in Q3 that its impact on GDP data should be minor.

Yes, the goods sector of the US economy has seen better days. Some companies in the goods sector, like Peloton and CarMax, have gotten hammered because they seemed to project forward COVID-like economic conditions forever, including lockdowns. Or, maybe they just had business models whose problems could be better hidden when the federal government was passing around stimulus checks like candy. That was unwise and these companies are paying for it now as the balance between goods and services returns toward normal.

It should be no wonder the US is not in recession yet. Until two weeks ago, the Federal Reserve hadn’t raised short-term rates above the 2.5% level it thinks is the long run average. Even at current levels, short-term rates are still well below inflation.

Yes, growth in the M2 measure of the money supply slowed sharply starting in February but as Milton Friedman taught us (unlike those at the Fed who are still ignoring his lessons), the link between growth in the money supply and inflation is long and variable.

In addition, there are reasons to question whether the slowdown in M2 money growth means tight money. The Treasury now holds a very large balance in its checking account at the Fed – The “Treasury General Account.” So far in 2022, the Fed has collected roughly $480 billion in taxes or bond sales that it deposited at the Fed and did not spend. This subtracts from M2, at least temporarily.

Why the Treasury needs such a large amount of cash sitting around is a mystery. Especially when it has a massive structural annual budget deficit. As a result, we believe this can’t continue, and so it remains to be seen whether the slowdown in the growth of M2 will persist.

In the meantime, rate hikes, which have already impacted the housing market will likely cause a recession by the second half of next year, with some probability of it starting early next year and some probability it starts as late as 2024. There is more economic pain to come; in certain areas, like the labor market, the pain is almost completely in front of us, not behind.

The attached information was developed by First Trust, an independent third party. The opinions are of the listed authors at First Trust Advisors L.P, and are independent from and not necessarily those of RJFS or Raymond James.  All investments are subject to risk. There is no guarantee that these statements, opinions, or forecasts provided in the attached article will prove to be correct. Individual investor's results will vary. Past performance does not guarantee future results. Forward looking data is subject to change at any time and there is no assurance that projections will be realized. Any information provided is for informational purposes only and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected.

Understanding the Fed (or at Least Trying!)

Thoughts of the Week

Eugenio J. Aleman, PhD, Chief Economist

Giampiero Fuentes, CFP, Economist

Over history, it has not been easy for markets to understand the Federal Reserve (Fed) or how the Fed understands its role, even if its two most important mandates, which are very clear, are price stability and low unemployment. At some point in time, during the tenure of Alan Greenspan, the communications from the Fed were so convoluted that analysts/economists would call Fed communications ‘Fed-speak,’ which basically meant that they could not understand a word of what Mr. Greenspan was saying!

However, today is different. The Fed has gotten much better at communicating what its thoughts are today and going forward. The only problem is that the Fed is like the family doctor: you call the doctor because you feel bad, and the doctor prescribes a very nasty medicine and says that you must take it all during the next several weeks.

Today, markets have been calling the doctor because they have an inflation problem. However, the medicine the doctors are recommending is too nasty to take, let alone do it for the next several months or even quarters.

We don’t think markets were surprised by the 75 basis point increase in the federal funds rate decided after the September Federal Open Market Committee (FOMC) meeting earlier this week. The Fed chairman, Jerome Powell and other members have been filling the airways with a more certain view of the path ahead. What happened after the FOMC meeting this week was that the Fed put a price or, as many would say today, ‘monetized,’ what Fed officials have been saying since the Jackson Hole meeting.

And markets did not like this monetization because it means higher interest rates for a longer period and probably a deeper recession than what they had already priced in.

On Deflation, Inflation, Stagflation, and Disinflation

But let’s try to understand why the Fed seems to have changed its mind about the need to move higher and stay higher for longer. First, it believes, and markets have made it clear, that it was behind the curve by not acting immediately to curb inflation after the inflation monster reared its ugly head. However, for an institution that has been fighting deflation for several decades, this is a ‘peccadillo’ that should have been pardoned already, but markets keep blaming the Fed for not acting on it.

Second, it has been hearing some analysts/economists throwing the word ‘stagflation’ out without any regard for the insurmountable differences that exist today compared to the 1960s, 70s, and 80s (See our Weekly Economics for June 10, 2022). If the Fed had bad policies that tended to perpetuate higher inflation for longer, what do we say about the bad, bad, even atrocious (political) policies pushed during the 1970s that worsened the effects of inflation and created a perfect storm for stagflation to take hold? Not saying that some of today’s policies are great, but nothing compared to what was happening then.

Having said this, the Fed is nevertheless concerned that if it does not act forcefully to control inflation today, high inflation will become the norm and inflation expectations will become entrenched at a higher level. So far, this is not happening, as shown by the different measures of inflation expectations, but it has become highly risk-averse regarding inflation.

Thus, the Fed doesn’t want to risk it and be accused of being soft on inflation as was the case with its colleagues of the stagflation period. That is, Powell and company don’t want to act as the Fed did during the 1960s, 70s, and early 80s and allow inflation to get the upper hand. It just wants markets to take the medicine in full rather than allow the ‘infection,’ i.e., inflation, to come back again and with greater force. And you cannot blame it for not wanting to be compared to those folks.

Third, the Fed, as well as many analysts/economists, were expecting inflation to start turning the corner at the end of the first quarter of this year (yes, this was the ‘transitory’ argument) but a new and unexpected external shock changed the timing for inflation to start coming down: the Russia/Ukraine war. Thus, the Fed doesn’t want another potential external shock to further undermine its inflation fighting credibility and has decided that this time around, it is not waiting for things to happen on their own, and it is ok with increasing interest rates further and pushing the US economy into a recession.

Fourth, because of all this, the Fed is expecting inflation to come down at a slower pace than what it was expecting before through a process that is called disinflation. And it is betting the house on its success. This is the reason why the strategy has changed to ‘higher for longer.’ The Fed has put out its worst-case scenario, something that should be music to the markets’ ears.

For the markets, this should be good news even if it is very difficult to see it at this point. Since this is the worst-case scenario for the Fed, any ‘better-than-expected’ news in the inflation front should be a boon for markets

NAHB Housing Index: The NAHB/WF Housing Market Index continued to decline in September, which is another clear indication of the impact of higher mortgage interest rates on sales of single-family homes. Additionally, we expect the other housing market releases this week (housing starts, existing home sales, and building permits) will show similar weakness. Bad news continues to be good news for the Fed, as it indicates its tightening cycle is working to slow demand. The NAHB/WF Housing Market Index dropped further in September to 46 from a reading of 49 in August, while consensus was expecting a reading of 48. This was the ninth consecutive monthly decline in the index, taking it further below the all-important 50 break-even level, suggesting additional deterioration in the US housing market. The index for current single-family sales remained above the 50-demarcation point, at 54, but the index for single-family homes in the next six months dropped to 46 compared to 47 in August. Similarly, prospective buyer traffic continued to shrink to a level of 31. Most of these indicators are hovering around their lowest levels since 2014 if we take out the decline induced by the COVID-19 pandemic in 2020. The only region that remained barely above the 50-demarcation point continues to be the South, with a reading of 52. Furthermore, the Northeast reported a reading of 48 compared to 49 in August, while the Midwest remained unchanged at 42, and the West dropped even further in September to 34. With mortgage rates continuing to increase and the NAHB/WF Housing Market Index remaining below the 50-demarcation level between expansion and contraction, the housing market is slowing down and is likely to continue to do so. Although the current single-family index for sales remained above 50, the forward-looking part of the index showed very weak expectations going forward.

Housing Starts & Building Permits: Housing starts bounced back in August after plunging in July, recovering to the June 2022 levels. While both segments (single family and five or more units) increased, multi-family housing led the charge as higher mortgage rates and rents are increasing demand for more affordable housing. On the other hand, building permits experienced the largest decline since the pandemic began in March 2020, reaching their lowest level since June 2020. Overall, tighter monetary policies continue to negatively impact the housing market and are making home ownership unaffordable to many. Housing starts in August increased to a seasonally adjusted annual rate of 1.575 million or a 12.2% increase compared to the revised July estimate of 1.404 million, according to the US Census Bureau and the US Department of Housing and Urban Development. This represents approximately the same level reported in August of last year. Single-family housing starts were 935,000 in August or 3.4% higher than the 904,000 million reported for July. On the other hand, building permits declined 10% in August, down to 1.517 million from 1.685 million in July. Compared to August 2021, building permits are down 14.4%. Single-family building permits were 899,000 in August, or 3.5% below the revised July level of 932,000. Building permits of five or more units were 571,000 in August, compared to 701,000 in July. Housing completions were at a seasonally adjusted annual rate of 1.342 million or 5.4% below the July revised estimate of 1.419 million, and 3.1% above the August 2021 rate of 1.302 million. With the average 30-year mortgage rate exceeding 6%, both builder sentiment (as shown in yesterday’s NAHB/WF release) and buyers’ ability to afford single-family homes continued to decline. Looking ahead, as the Fed continues to raise rates to tame inflation, the housing market is likely to get gloomier.

Existing Home Sales: Existing home sales continued to decline in August both on a month-over-month basis as well as compared to last year. Home prices for existing home sales were down compared to July but they are still positive year-over-year. Meanwhile, the supply of homes held steady, at 3.0 months, in August and on a seasonally adjusted basis. Existing home sales decreased by 0.4% in August, to a seasonally adjusted annual rate of 4.80 million according to the National Association of Realtors. Compared to August of last year, existing home sales declined 19.9%. The decline in existing home sales in August was less than what consensus was expecting. The median sales price of existing home sales was $389,500 in August, down from a median sale price of $399,200 in July. Home prices were up 7.7% versus August of last year for the US as a whole. Regionally, they were up 1.5% in the Northeast, 6.6% in the Midwest, 12.4% in the South, and 7.1% in the West, all compared to the same month a year earlier. Although existing home sales were stronger than the consensus expected in August, they were still down compared to July while the median price of existing homes continued to decline, a clear signal that the housing market continued to weaken in August.

Initial Jobless Claims: This was the first increase in jobless claims in several months, but claims remain at non-recessionary levels. This means that the labor market is still strong and higher interest rates are still not having the effects the Federal Reserve has been looking for. Initial jobless claims increased by 5,000 during the week ending on September 17, to a level of 213,000, according to the Department of Labor. This was the first increase in initial jobless claims since early August. However, the four-week moving average was still down, by 6,000 from the previous week, at 216,750. Meanwhile, the advanced seasonally adjusted insured unemployment rate was 1.0% for the week ending September 10 and unchanged from the previous week. There was no state reporting an increase of more than 1,000 claims during the week ended on September 10, 2022, while there were six states reporting a decline in claims of more than 1,000. The states were CA with 3,064 less claims but no sectoral comments; NY, with 2,905 fewer layoffs in the transportation and warehousing, health care and social assistance, and real state and rental and leasing industries; TX, with 2,493 less claims but no sector comment; OK with 1,729 less claims but no comments on the sectors affected; PA with 1,355 less claims in the transportation and warehousing, accommodation and food services, construction, and health care and social assistance industries; and GA with 1,337 less claims in the administrative and support and waste management and remediation services, transportation and warehousing, professional, scientific and technical services, and health care and social assistance industries.

Leading Economic Index: The Leading Economic Index (LEI) continued to point to a weakening US economy in August. We should continue to see weakness in the LEI in the coming months as higher interest rates continue to weigh on the strength of the US labor market. The Conference Board Leading Economic Index declined 0.3% in August, to 116.2, after posting a decline of 0.4% in July. This was the sixth consecutive monthly decline for the index and the Conference Board projects a recession in the coming quarters. This is because of the Federal Reserve’s (Fed) rapid tightening of monetary policy, which ultimately will have an impact on the labor market, as suggested by a Senior Director at the Conference Board: “Labor market strength is expected to continue moderating in the months ahead. Indeed, the average workweek in manufacturing contracted in four of the last six months—a notable sign, as firms reduce hours before reducing their workforce.” The Fed’s hawkish tone at the Federal Open Market Committee meeting on September 21 indicated that interest rates will be higher for longer, with a forecasted federal funds rate at ~4.5% by the end of the year. This LEI reading just confirms our view of a weakening economic environment in the US, and, with the Fed now expected to hike rates into restrictive territory, the US economy is likely to enter a recession in the next quarters.

DISCLOSURES Economic and market conditions are subject to change. Opinions are those of Investment Strategy and not necessarily those Raymond James and are subject to change without notice the information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur last performance may not be indicative of future results. Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Studies. Currencies investing are generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising. Consumer Sentiment is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample. Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior. Consumer confidence index is an economic indicator published by various organizations in several countries. In simple terms, increased consumer confidence indicates economic growth in which consumers are spending money, indicating higher consumption. The Consumer Confidence Index (CCI) is a survey, administered by The Conference Board, that measures how optimistic or pessimistic consumers are regarding their expected financial situation. Leading Economic Indicators: The Conference Board Leading Economic Index is an American economic leading indicator intended to forecast future economic activity. It is calculated by The Conference Board, a non-governmental organization, which determines the value of the index from the values of ten key variables Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements. Source: FactSet, data as of 9/23/2022

More Trouble Ahead

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

September 26, 2022

We had been bullish on stocks all the way back to March 2009, when mark-to market accounting was fixed and the Financial Panic started to recede. At that time the S&P 500 traded as low as 677. What a time to buy!

After that we remained bullish. We didn’t recommend selling in spite of a wide range of fears that spooked many others, including the Great Recession lasting through 2010, a double-dip recession, a second wave of home foreclosures, an implosion in commercial real estate, the passage of Obamacare, a Greek debt default, a potential breakup of the Eurozone, the Fiscal Cliff, Brexit, or the election of President Trump. While others bailed out way too early on the bull, we kept riding.

We rode it so long that some called us “perma-bulls.” But as we looked at low interest rates and healthy profits, we didn’t see any other choice.

Then in June we announced we were bullish no more. In particular, we said “we don’t expect the S&P 500 to hit a new all-time high, above the old high of 4,797, anytime soon.” Instead, until one of our two scenarios plays out – a recession or the realization the Fed has pulled off a soft-landing – US equities are likely to be in a trading range with potential bear market rallies that come and go.”

We still expect the much more likely scenario is that a recession will arrive sometime in 2023 (possibly early 2024) and that stocks will remain in a bear market until the recession hits. Why a recession? Because the Federal Reserve will have to get tight enough to reduce inflation toward its target and a monetary policy that’s tight enough to control inflation is going to send the economy into a recession.

Back in June we said that stocks could easily rally from then-current levels, when the S&P 500 was at 3675, but that such a rally wouldn’t last. After that the S&P rallied up to a closing high of 4305 in mid-August before dropping to 3693 at Friday’s close. Don’t be surprised by other bear-market rallies, which will also fade.

As always, we used our Capitalized Profits Model to assess fair value for the stock market. The model starts with the government’s measure of economy-wide corporate profits and uses the yield on the 10-year Treasury Note to discount those profits.

The yield on the 10-year Treasury Note finished last week right around 3.70%, which, when plugged into our model, suggests fair value for the S&P 500 is about 3600. That would be a 2.5% decline versus the Friday close.

But long-term yields may go higher from here. With a 4.00% yield on the 10-year Treasury, the model says fair value on the S&P is about 3325, which would be a 10% drop versus Friday’s close. And even if long-term yields don’t go higher from here, approaching and entering a recession is highly likely to eventually cut corporate profits. Either way, there are reasons to expect we haven’t seen the bottom yet for stocks.

A couple of things to keep in mind. If you’re a very long-term investor who doesn’t want to time the market, none of this discussion matters much. Just maintain your normal allocation to stocks and don’t be shy about continuing to buy stocks at your normal intervals. That way you’ll be buying at low stock prices, too, and stocks should be worth substantially more when you’re spending down assets in the far away future.

However, those investors willing to take some risk on timing the market should consider that the future year or so probably includes better entry points for broad stock indexes than today’s levels.

The attached information was developed by First Trust, an independent third party. The opinions are of the listed authors at First Trust Advisors L.P, and are independent from and not necessarily those of RJFS or Raymond James.  All investments are subject to risk. There is no guarantee that these statements, opinions, or forecasts provided in the attached article will prove to be correct. Individual investor's results will vary. Past performance does not guarantee future results. Forward looking data is subject to change at any time and there is no assurance that projections will be realized. Any information provided is for informational purposes only and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that's generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary.

High Frequency Data Tracker

First Trust Economics

Brian S. Wesbury - Chief Economist

September 23, 2022

We live in unprecedented times. The recession in 2020 was not so much a recession as it was a lockdown. Using “normal words” to describe the economy in the last 2 years, we believe, does not make sense. Now with two consecutive quarters of declining real GDP, many are saying we are back in a recession. The charts in the High Frequency Data Tracker follow data that are published either weekly or daily, providing a good real-time look at where the economy stands. As of now we believe these measures, along with other monthly economic data coming in, show we are not in a recession.

To view more important information regarding this click on the link below!

https://www.ftportfolios.com/Commentary/EconomicResearch/2022/9/23/high-frequency-data-tracker-9232022