Guest Post: Financial Markets and Economic Update for the Third Quarter 2026

Bond Vigilantes

When the bond market leads the Federal Reserve, they usually must follow or face the wrath of the bond vigilantes.  They’re back!  The Fed Funds futures markets had a 94% chance of a rate hike at the September 16^th FOMC meeting.  The 2-year Treasury yield rose by 61 basis points since the end of the second quarter; the 10-year Treasury rose by 60 basis points and exceeded 5.00% as of now.  The FOMC unanimously raised the Fed Funds rate by 25 basis points to 3.75% to 4.00%, for the first hike since July, 2023.  Be careful what you wish for as the Fed rarely stops at one single increase in Fed Funds once they start tightening.

The bond vigilantes have been protesting all quarter, but especially in September.  They pushed rates up to combat inflation uncertainty, high oil ($102), gas ($4.47), and diesel ($6.44) prices because of the Ukraine war and Iran conflict (or should I call it a standoff?), and rising commodity prices (supporting the dollar).  Global debt is rising as capital investment for AI and manufacturing plant buildouts increases demand for long term debt.  The federal government deficit has pushed Treasury issuance up with $40 trillion+ now outstanding.  Or maybe the vigilantes are just protesting Maria Bartiromo’s exit from Fox News on September 3rd.

So, bond vigilantes, what’s next for the 10-year Treasury yield?  4.50% or 5.50%?

Inflation

With the new Fed Chairman, Kevin Warsh, now in place, I am watching Fed news conferences again.  When asked why the Fed projections still show it would take two years to get to the PCE goal (as I’ve been complaining about for years), Warsh almost laughed.  He simply said inflation is too high and we must get to the 2.0% goal in a quicker, more timely fashion.  At 3:00, he answered a question, snatched his papers, and abruptly walked out.

I agree that inflation measures year-over-year are too high, as evidenced by CPI (August) at +3.4%, PPI (August) at +5.4%, and PCE (July) at +3.7%.  Core CPI (August) was at +2.4% (which is at the implied target), core PPI (August) at +4.6%, and core PCE (July) at +3.3%.  In the 2s for all would be infinitely better.

There are measures that are much lower- Truflation, which is a set of indices developed in December 2021 to replicate CPI and PCE, but digitally in real time for 13 million goods and services on a daily basis, eliminating the survey process for thousands of prices and delays of the standard CPI and PCE measures.  As of September 18^th, Truflation y-o-y for CPI was +2.4% versus the standard CPI at +3.4% and for PCE was +2.5% versus the delayed +3.7%.  Truflation has been under 3.0% for all of 2026.  For Bloomberg users, the ticker is TRUFUS44.  Let’s hope the Fed task force on inflation at least considers this metric.  What do you think about Truflation?

Rogue AI

We’ve heard about several instances of AI models breaking their containment or testing environment and going where they should not go- to the Internet and onto companies’ websites.  Open AI’s agent escaped the test environment, got onto the Internet, and hacked the servers of Hugging Face.  Google’s Gemini hacked and accessed three real companies’ websites by obtaining or guessing passwords.  Anthropic’s Mythos and Meta’s Llama both broke out of their containment and Mythos uploaded malicious software to a site.  Alibaba’s AI model found sites on the Internet and started mining cryptocurrency.  What next?  It’s clearly a risk that companies and individuals must contemplate sooner rather than later.

Some of My Favorite Economic Indicators

Leading Economic Indicators (LEI)- The up and down pattern of 2026 continues.  August’s LEI was -.1%, July was +.2%, and June showed no change.  In the past 42 months, 33 months were negative, 5 months had no change, and 4 months were positive (all in 2026).  Recent trends are not telling us much about future growth.  The many months of downturn over the past 3.5 years didn’t tell us much about growth either, as the LEI kept pointing to recession that never came.

Real GDP- Speaking of growth, it’s been holding in there, with 2Q26 at +2.1% and 1Q26 at +1.5%.  As far as the 3Q26 projections by the Atlanta Fed, GDP Now stands at +5.1% as of now.

Moody’s Beige Book Index- The most recent report for September showed 10 districts with increasing growth and two with unchanged growth.  Philadelphia is increasing this time.  The Moody’s Beige Book index is higher again in September at 63.9, compared to 44.4 in July and 36.1 in June.

M2 Money Supply- M2 y-o-y growth has been solid.  July was +5.4%, June was +5.3%, May was +5.4%, and April was +4.5%.  This increase in money supply is supporting GDP growth.

Productivity- This measure improved in 2Q26 to +1.4%, following +.8% in 1Q26.  Unit labor costs were modest at +1.2% and +1.3% in 2Q26 and 1Q26, respectively.  Productivity is at a level now that can support a portion of wage increases.

Housing- Prices continue to moderate on a y-o-y basis.  Case Shiller was +2.1% in June versus May of +1.6%.  FHFA for June was +2.3% versus May of +2.4%.  Moody’s HPI was +1.9% in July versus June of +2.2%.  Existing home median sale prices rose +1.6% in August.

Federal Reserve Task Forces

“It’s been a long time coming but I know a change is gonna come.”  Sam Cooke

Kevin Warsh is forcing change at the Fed.  Five task forces were created to study their subjects and report back by year-end 2026 at the latest.  These task forces are: 1. Communications (i.e. no press conferences!), 2. Balance sheet policy and management, 3. Quality and timeliness of data sources, 4. Productivity and costs including technology and AI, and 5. Inflation framework.

September 11^th

I can clearly remember that fateful day 25 years ago.  The feelings of dread, sadness, horror, and helplessness are still there.  The feeling of deep loss remains over the loss of my friends at Sandler O’Neill who were killed that day.  They were so proud of their offices on the 104^th floor of the South Tower.  Each year, on September 11^th, I think of them and vow to never forget them.  They went to work that morning and had no idea of the tragedy to come.  So here goes- Stacey, Gus, Herman, Chris, Jeff, Kevin, and Judd.  And to Anthony, who I met after the tragedy and who was not there that day, I think of you as well.  God bless you all.

Thanks for reading!  As always, I appreciate your support!  DLJ 09/20/26

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy recently retired from Penn Community Bank where she worked since 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.

Disclaimer: This publication is provided to you solely for educational and entertainment purposes.  The information contained herein is based on sources believed to be reliable but is not represented to be complete and its accuracy is not guaranteed.  The expressed opinions, views, and estimates are those of the author as of this date and are subject to change without notice.  The author cannot provide investment advice but welcomes your comments.

Guest Post: Financial Markets and Economic Update Fourth Quarter 2025

I had the best fourth quarter!  I’ve always wanted to visit Europe’s Christmas Markets and finally did in late November to early December on a Viking River Cruise from Budapest to Regensburg.  We loved Budapest, especially with both sides of the Danube River lit up at night.  We loved the Christmas Markets, especially in Budapest, Vienna, and Salzburg.  The best mulled wine was in Salzburg, which is an amazing city close to the Alps with so much culture and history.  The best food was in Regensburg.  It was special to sail from place to place, exploring, learning, shopping at Markets, listening to concerts, and enjoying every day.  For me, it is a dream come true and was actually a retirement gift, booked over two years ago.

Government Shutdown

We all saw it coming.  The government shut down on October 1^st when the Senate could not get 60 votes to get a continuing resolution passed.  Whatever happened to annual budgets, I’ll never know.  We keep pushing the current spending levels ahead by a few months.  Democrats first demanded $1.5 trillion in additional spending, including extension of Obamacare subsidies, which they themselves allowed to expire at the end of this year, but the Republicans held firm.  No.  Finally, in November, eight Democrats crossed the aisle to get to the 60 votes needed to pass the continuing resolution and reopen government, but with a near-term expiration of January 30^th.  It was the longest shutdown in history at 43 days.

So, we get to go through this madness again?  Government employees not getting paid, air traffic controllers not coming to work consistently, SNAP or food stamp benefits delayed, and government economic data suspended were all big negatives.  Republicans are not going to fund insurance companies in the failed Obamacare ACA anymore, they will not extend covid subsidies (covid is over!), and they will no longer pay for illegal immigrants. 

During the shutdown, NASA was busy tracking 3I Atlas, which they call a “comet” streaking across our solar system.  Is it a comet?  Is it an alien spacecraft?  Today, it makes its closest pass to Earth, albeit several hundred million miles away.  We shall see if the ETs send us a message.

Inflation

CPI for November surprised to the downside at +2.7% year-over-year; the core CPI was +2.6%.  CPI typically runs about .50% higher than PCE, upon which the Fed targets are set.  CPI is almost there to its implied target of +2.5%.  However, we only have PCE figures from September, which were +2.8% for the headline and core measures. 

There are plenty of hopeful signs that inflation will be declining in 2026.  Crude oil has fallen from nearly $80 per barrel to $55 this year.  Gas prices broke below $3.00 to $2.90 per gallon now.  Large increases in owners equivalent rent are fading, mainly due to deportations of illegal immigrants.  There is room for improvement in electric and natural gas prices, which rose +4.2% y-o-y, as capacity increases and regulations are reduced.  Food prices are tempering; one example is the cost of a Thanksgiving dinner in 2025 fell -5.2% from 2024 to $55.18.

Affordability is the big political buzzword right now.  The past four years brought us the highest inflation in two generations, from explosive government spending, supply chain issues, and a slow reacting Fed that fueled a spike in the CPI index of +20% between 2021 and 2024.  Expect CPI to continue its decline in annual pace, but it will be difficult to overcome the 20% increase in the level of CPI without deflation.  Focusing on growing real wages will certainly help with affordability.

Housing

Housing inflation is clearly down in this struggling sector.  Recent reports show y-o-y price increases diminishing, including the S&P/Case Shiller at +1.4% in September, FHFA at +1.7%, Moody’s at +2.0%, and existing home median sales prices at +1.2%.  Zillow reports that 53% of homes nationally have lost value in the year ended October, 2025, which is the highest percentage increase since April, 2012.  Prices in the Northeast are stable.  There’s a slowdown in demand, with existing home sales up only +.5% in November.  Inventories remain an issue with scarce supply at 4.2 months’ worth of sales.

Mortgage rates continue their painfully slow decline, with the 30-year rate at 6.21% according to FHLMC.  Monthly mortgage payments are still unaffordable for many potential buyers.  Property taxes in many counties are rising along with prices, and in many cases along with declines in value, adding to the angst of existing and potential homeowners.  Due to the government shutdown, new home sales data is delayed.

Some of my Favorite Economic Indicators

Leading Economic Indicators (LEI)- This Conference Board indicator was released for September and the trend continued to be negative, with September and August each at -.3%, leaving the index at 98.3 (2016=100).  For 36 of the last 40 months, the index has been negative.  Four months registered no change:  July, 2025, May, 2025, November, 2024, and March, 2024.  There was once a time that, when the LEI was negative for over 6 consecutive months, recession would follow 6 to 9 months later.  So what are we to make of this index falling for over three years, continually signaling a recession that never came?   By the way, the yield curve inversion lasted for years, also signaling a recession.  With Federal Reserve easing, $10 trillion of new investment in manufacturing in the US committed, strong stock markets and earnings prospects, and fiscal stimulus in 2026, I don’t see recession coming soon.

Employment- Job growth has been showing weakness for months.  I can’t help but wonder how much of the decline in payrolls is related to deportations/immigration and cuts in government jobs.  Payrolls rose in November by +64,000, fell in October by -105,000, and rose in September by +108,000.  The unemployment rate rose to 4.6% in November from 4.4% in September.  A bad sign is that the pool of available workers is pushing 14 million, currently at 13.967 million.  Job openings are high in October at 7.67 million.  Quit rates fell below 2.0% to 1.8%, possibly showing workers unease about leaving jobs.  Challenger layoffs averaged 92,820 for the three months ended in November.  Wages rose +3.5% y-o-y in November; real wages have been positive for months.

Real GDP-  We have not received 3Q25 data yet, but the Atlanta Fed GDP Now projection is for +3.5%, following +3.8% in 2Q25, and -.6% in 1Q25.  Imports and inventories distorted both 1Q25 and 2Q25, as companies tried to get ahead of tariffs.  Real final sales strengthened to +2.9% in 2Q25 from +1.9% in 1Q25.  For the first time in a long time, the budget deficit is expected to decline as a percentage of GDP which will be slightly negative to growth.  Final tax changes from the OBBB include accelerated depreciation deductions for business investment and this will improve real GDP.  We are still held back by $38 trillion of US government debt, which is 126% of GDP; if greater than 90% for an extended time (since 2009), real GDP is impaired by about one-third.

Productivity- The talk is all AI, all the time.  Yes, AI will increase productivity and efficiency.  GDP can grow strongly without creating inflation if productivity is also strong.  (We witnessed this in the 1990s).  2Q25 productivity was +3.3% after a decline of -1.8% in 1Q25.  Capacity utilization is recently low at 77.4%, so we can afford to increase productive capacity without inflation.  And remember, if productivity meets its long-term average of +3.5%, employers are amenable to passing on 1.5% of it plus an inflation target of 2.0% for total raise of +3.5% without inflationary impacts.

Moody’s Beige Book Index- The index remained positive again in November at 11.1, following October of 13.9 and September at 0.  There were negative readings of -16.7 in July and -5.6 in June.  The latest Beige Book showed four districts increasing modestly, three with no change, and five in decline, including Philadelphia.

M2 Money Supply- M2 continues its upward growth trend at a steady clip on a y-o-y basis, with October at +4.6%, September at +4.5%, August at 4.4%, and year-to-date through October at +4.1%.  Milton Friedman would be pleased that M2 is increasing nearer to the growth rate of nominal GDP, after the Fed allowed M2 to outright decline for 15 months, from December, 2022 through February, 2024, for the first negative growth in M2 since the 1930s.  The velocity of M2 remains at 1.39 for both 1Q25 and 2Q25.  Expect M2 to continue to rise as QT has now ended.

Fed Actions

Another meeting, another rate cut.  That’s three in a row since September for a total easing of .75%, bringing Fed Funds to 3.50% to 3.75%.  The FOMC must have heard my criticism of their anemic GDP projections in September.  They now have raised their GDP projection to +2.3% in 2026.  But, true to form, they project taking two years to reach their inflation targets.  It’s always two years away!  It’s ridiculous!  Thankfully, Powell’s departure is not two years away.  I held to my pledge not to watch his press conferences in October or December and not to watch his BS, doublespeak, and “fog” worries ever again.  This is the same man I called a hero during the covid pandemic but his handling of inflation, QE and QT, and money supply turned me off for good.

The Fed finally ended QT on December 1^st.  They caused trouble in the money markets again by stubbornly refusing to ease enough.  Bank reserves are falling and there was great pressure on short-term funding rates.  SOFR was consistently above the IOR rate.  At the December meeting, they announced they will buy T-Bills as needed to help liquidity in the money markets; first up $40 billion of purchases.

The real Fed Funds rate is now about 1.00% (3.75% less PCE 2.8%).  There’s room to cut more.  Many economists estimate that the neutral rate for Fed Funds is 2.50% to 3.00%.

Year-End

We are almost there!  It will be Christmas before you know it!  We made it through a quarter where we saw:

•            On October 19^th, thieves stole $100 million in jewels from the Louvre
•            Jamie Dimon talking about cockroaches and loan losses
•            On November 12^th, the Philadelphia Mint produced the last penny.  It cost 4 cents to produce 1 cent.
•            A record government shutdown from October 1^st to November 13^th
•            Winter starting early with a snowstorm on December 14^th
•            The navigation of 3I Atlas throughout our solar system
•            Dorothy’s navigation of the Danube River

I wish you and your friends and families a Merry Christmas and a Happy New Year 2026!

I appreciate your support!  Thanks for reading!  DLJ 12/19/25

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy recently retired from Penn Community Bank where she worked since 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.

Disclaimer: This publication is provided to you solely for educational and entertainment purposes.  The information contained herein is based on sources believed to be reliable but is not represented to be complete and its accuracy is not guaranteed.  The expressed opinions, views, and estimates are those of the author as of this date and are subject to change without notice.  The author cannot provide investment advice but welcomes your comments. 

Guest Post: Financial Markets and Economic Update Third Quarter 2025

My third quarter started off with ten wonderful days in France- Paris, Noveant-Corny, and Mont Saint Michel.  I always said I didn’t want to go up into the Eiffel Tower, but this time I went to the second level, which was high enough for me.  The view is astounding.  The Notre Dame Cathedral is glorious once again, so clean, so beautiful!  We went to Mont Saint Michel off the coast of Normandy and to see the GIs Association, who welcomed our eighth visit since 2013 to spend time with them as they honor my Uncle Stephen and the men of the 5^th Infantry Division who fought there for their freedom in 1944.

We went to Atlantic City for two days but were chased by the hurricane at sea with rip tide risks, rough seas, and rain coming inland.  I’ll end the quarter with a trip to Rhode Island.

Stocks continue their upward climb.  Bonds are rallying despite the bond vigilantes’ best efforts.  The Phillies clinched the National League East for a second consecutive year last week and our hopes are alive again.  And on Sunday, the Eagles pulled off another comeback miracle to beat the Rams as, with two seconds left, Jordan Davis blocked a field goal, picked up the ball, and ran down the field to score a touchdown.  OMG!  As Merrill screamed, “Game Over!”

The Fed Lowers Rates- Finally!

Well, they finally did it!  We got a measly 25 basis point cut in the Fed Funds rate to 4.25% and no relief from QT liquidating of bonds, especially MBSs.  We are not much closer to neutral today than we were yesterday.  Some economists estimate the neutral rate to be 2.50% to 3.00%.  Adding to my frustration is the fact that the Bureau of Labor Statistics announced their annual payrolls revision for April, 2024 to March, 2025 of -911,000; 2024’s number was equally surprising and disappointing at -818,000.  They blame the small business birth-death ratio adjustment, yet they never seem to make any changes.  I’ve been writing about this for years!  Instead of average payroll growth of 146,000 per month during the revision period, we now have 71,000 per month.  Payrolls have gotten worse since then, with August adding only 22,000.  June’s number was revised to a negative number, or loss of jobs.  And the Fed gives us 25 basis points?  Last September, they cut 50 basis points when employment was not as dire.

Chairman Powell gave his obligatory press conference after the FOMC decision on September 17^th.  The statement he read was seemingly out of a textbook, with: dual mandates…we work for the American people…the rate cut was for “risk management” purposes…we are data dependent (backward looking)…we are well positioned, we were right to wait and see how tariffs, inflation, and the labor market evolved.  No, I’m sorry.  You were not right.  Are you and your FOMC members not embarrassed by your GDP projections of less than 2% for years?  Are you not embarrassed that you have not reached your PCE inflation target of 2% for the past five years and won’t achieve it, according to your own projections, for the next two years+?

And now I have a new goal- to avoid watching Powell’s press conferences for the remainder of his term.  I will not listen to his double speak, textbook excerpts, and refusal to acknowledge that reporters’ questions raise good points and deserve answers.  So, avoiding these press conferences will make my life simpler.  I can read about it later.    

Some of My Favorite Economic Indicators

Leading Economic Indicators (LEI)- This Conference Board indicator continues to slip, with August at -.5%, July revised +.1%, June -.3%, and May unchanged.  The Board’s recession signal was triggered in May and again in August.  For 35 of the last 39 months, the index has declined.  (Exceptions were a tiny rise in July, 2025, and unchanged readings in March, 2024, November, 2024, and May, 2025).  There used to be a time that, when the LEI was negative for over 6 consecutive months, recession would follow 6 to 9 months later.

Real GDP bounced back to +3.3% in 2Q25, following -.5% in 1Q25 with the tariffs/imports/inventories unusual activity, and +2.4% in 4Q24.  The latest Atlanta Fed GDPNow estimate for 3Q25 is +3.3%.  Tariffs can help create a diversified industrial economy which brings back manufacturing production that left the US over the years.  Increased investment in our country will lead to more domestic production, a stronger dollar, and lower inflation/lower rates.  Artificial intelligence has the potential to increase productivity, improving GDP while keeping inflation in check.   One note about headline GDP: it is masking the fact that real final sales have slipped to +1.9% in 1Q25 and 2Q25, following +2.9% in 4Q24.

Productivity improved in 2Q25 to +3.3% from a dismal -1.8% in 1Q25.  Higher productivity affords companies the chance to increase production and keep costs in check, i.e. lower inflation.

Moody’s Beige Book Index- In a follow up to last quarter’s newsletter, the September index returned to zero from its negative readings of -16.7 in July and -5.6 in June.  The latest Beige Book showed six districts increasing modestly, including Philadelphia, two with no change, and four in decline.  Half the country is begging for lower rate relief…

Unemployment continues to get worse and the rate rose to 4.3% in August from 4.2% in July.  Payroll growth was anemic at +22,000.  Household growth was +288,000, showing a real dichotomy in the two surveys.  The pool of available workers (a Maestro favorite) is currently at 13.738 million.  The augmented rate derived from this pool rose to 7.8% in August from 7.6% in July.  Employer demand for hiring has definitely slowed; with the previously mentioned benchmark revisions, markets are uncertain and skeptical about having accurate employment measures.  Some mention the Quarterly Census of Employment and Wages, or “QCEW,” as a better source, but its release would not be timely enough.

The M2 money supply continues its upward growth trend, with August and July y-o-y at 4.8%, June +4.5%, and May and April +4.2%.  Milton Friedman would be pleased that M2 is increasing nearer to the growth rate of nominal GDP, after the Fed allowed M2 to outright decline for 15 months, from December, 2022 through February, 2024, for the first negative growth in M2 since the 1930s.

Housing- August was a dreary month for housing starts -8.5% and permits -2.3%.  Builders have not yet cut back on rate buydowns and price discounts/incentives as new home sales rose +20.5%, paring inventory to 7.4 months’ worth of sales from 9.0 months in July.  Mortgage rates have provided some relief recently, with the 30-year at 6.35%, which is clearly better than earlier this year.  But affordability is still holding back buyers.  Inventories for existing homes are still tight at 4.6 months’ worth of sales.  Mortgage rates above 6% are still not low enough to encourage widespread sales of existing homes with mortgages below 4%.

Inflation

The headline CPI for August was +2.9% y-o-y; the core rate was +3.1%.  Goods prices y-o-y were +1.5%, showing little effect from tariffs, while services were +3.6%.  PPI for August was +2.6% and the core was +2.8%.  PCE for July was 2.6% and the core was +2.9%.  PCE is the Fed’s preferred measure and their 2.0% targets are based on PCE.  Their targets are not based on CPI, which generally has run about .40% to .50% above PCE.  So consider 2.5% a target for CPI.  One of Powell’s few revelations from the recent press conference was that the Fed thinks that tariffs have added .30% to .40% to the inflation level so far.

When Will the Yield Curve be Normal, i.e. Positive?

The Fed’s restrictive stance has distorted the yield curve for several years now.  The curve was inverted for 26 months for the 10-year Treasury to the 2-year Treasury from July, 2022 to September, 2024;  the 10-year Treasury to the 3-month T-Bill was also inverted for 26 months from October, 2022 to December, 2024.  The usually historical prediction from both of these inversions for a recession never came true.  Since 2024, we’ve seen flat curves, parts of the curve steeper such as 10-year to 2-year Treasuries, and an inverted curve for 10-year to 3-month Treasuries before it became positive again with the September 25 basis point rate cut.  Bond vigilantes attacked again, right after the Fed announcement on September 17^th.  The 10-year Treasury was close to breaking 4% to the downside, but traders quickly sent it up 10 basis points.  In protest of something, I guess…

If the Fed continues to ease toward neutral, which could be 2.50% to 3.00%, long-term rates could decline, not in tandem , but about 50% of the move in short-term rates.  That would be “normal” and would help the cause of lower mortgage rates.  Slowing of QT in MBSs would help lower mortgage rates, too.  By the way, the historical average of the10-year Treasury to 3-month T-Bill spread is about 1.10%; for the past 10 years, it has been about .80%, pulled lower by years of low inflation prior to 2021.  Today, the spread is .19%

Happy Events

I mentioned our trip to Paris in July.  It is very special exploring that city.  And Mont Saint Michel!  I must admit, I really needed to catch my breath after climbing 300+ steps up to the Abbey.  What a glorious feeling it was to be at the top of this mountain.  Views are spectacular.  The feeling is very spiritual when thinking about the millions of people who have made this journey before us to the island and climbed this mountain.  Saint Michael, protect us!

I appreciate your support!  Thanks for reading!  DLJ 09/24/25

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy recently retired from Penn Community Bank where she worked since 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.

Disclaimer: This publication is provided to you solely for educational and entertainment purposes.  The information contained herein is based on sources believed to be reliable but is not represented to be complete and its accuracy is not guaranteed.  The expressed opinions, views, and estimates are those of the author as of this date and are subject to change without notice.  The author cannot provide investment advice but welcomes your comments.

Guest Post: Financial Markets and Economic Update-Second Quarter 2025

The second quarter of 2025 has been full of drama and lots of rain in southeastern PA.  We’ve arrived at the start of summer and a 100-degree heat wave after witnessing a stock market meltdown over tariffs and a subsequent recovery.  The bond market saw wild swings in Treasury yields and the return of the bond vigilantes.  We experienced lots of tariff news, wondering about the Federal Reserve, unrest in Los Angeles over ICE in a community already reeling from the Palisades fire in January, and most recently, bold targeted strikes by our military on nuclear sites in Iran.

Why Aren’t You Lowering Rates, Jerome?

We’ve been wondering… You told us repeatedly that you would lower interest rates before inflation gets to your target of 2.0% on PCE (personal consumption expenditures inflation index).  Well, we are inching closer with PCE at 2.3% in May.  You are now targeting tariffs as your reason for not easing.  You just projected real GDP at +1.4% to +1.6% for this year and next, which I guess you don’t see as “weak.”  You continually say you “don’t know” what the effect of tariffs will be, but you happily increased your inflation projection for 2025 to 3.0% and lowered your GDP growth projections to +1.4% in 2025, +1.6% in 2026, and +1.8% in 2027.  Is that slow growth for so long acceptable in any scenario?  You just stated that growth is “solid,” yet the June Beige Book report showed that 9 of your 12 districts show declining or flat growth, including the Philadelphia region with a modest decline.  The Moody’s Beige Book Index fell to a negative number in June for the first time I can remember; it fell to -5.6 from 19.4 in May.  Doesn’t that bother you?

Several analysts recently have questioned why the FOMC always votes 12-0, including your most recent June 18th decision to keep rates and QT (quantitative tightening) unchanged; i.e. you are all doing nothing.  I suppose this FOMC “dozen” will wait and watch as growth gets strangled by your unreasonably high Fed Funds policy rate, which is, by the way, tied for highest in the world!  Everyone else is easing!  At least you are no longer Phillips curvers as you project both inflation and unemployment to rise.  As Powell said: “The current stance of monetary policy (do nothing) leaves us well positioned to respond (do nothing) in a timely way (always very late).”  It’s gratifying that 3 Fed governors have come out since the June meeting saying they will support rate cuts.   

Some Indicator Favorites

Leading Economic Indicators (LEI) continue to be negative month after month, and the duration of these negative readings confounds me and others.  The LEI in May fell -.1% to 99, following April’s decline of -1.4%, and has been negative for 34 of the last 36 months (exceptions were March and November, 2024).  There used to be a time that, when the LEI was negative for over 6 consecutive months, recession would follow 6 to 9 months later.  Not anymore.

Real GDP was -.5% in 1Q25 and was impacted by a huge amount of imported goods purchases to get ahead of tariffs.  Without the negative impact of imports and inventory offsets, growth probably was about +2.0%.  Growth in 4Q24 was +2.4%.  The Atlanta Fed projects 2Q25 at +2.9% and the Fed’s June projection puts GDP at +1.4% for all of 2025; nominal growth will likely be below +4.0%.

Productivity had a terrible reading in 1Q25 at -1.5%, following +1.7% in 4Q24.  This harms the formula for acceptable wage growth that would not be inflationary: 2.0% inflation target plus +1.5% long-term productivity growth totaling +3.5%.  In May, year-over-year wage growth was +3.9%.

The labor market is showing signs of weakness.  The unemployment rate was 4.2% in May.  Payroll growth was only +139,000 while household growth fell -696,000.  The pool of available workers has risen to 13.228 million and the augmented unemployment rate was 7.5%.  Yikes!  Maestro just perked up!

The M2 money supply is supposed to grow at approximately the same pace as nominal GDP per Milton Friedman.  Nominal GDP was +3.2% in 1Q25 and was +4.8% in 4Q24.  M2 year-over-year growth was +4.5% in May, +4.4% in April, and +3.6% in December.  The Fed is finally catching up, after they allowed M2 growth to turn negative for 15 months, from December, 2022 through February, 2024, for the first negative growth in M2 since the 1930s.  Is this worse than tariffs?  You bet!

Inflation

Inflation has been on the decline for the past several months, despite tariff fears.  For May (year-over-year), CPI was +2.4%, core CPI was +2.8%, PPI was +2.6%, PCE was +2.3%, and core PCE was +2.7%.  This leaves Fed Funds of 4.50% at a spread of +1.7% to 2.2% (the real rate- more below) above these inflation rates.  It sure looks like PCE of +2.3% is close to the target of +2.0% and CPI is slightly below its implied target of +2.5% (+.5% to PCE).  Still, the Fed will not ease. 

Why not?  PCE fell below +3.0% in October, 2023, when Fed Funds was 5.50%; this rate remained there until September, 2024, when the Fed suddenly eased by .50%.  We want to look at the real Fed Funds rate at equilibrium.  Currently, that real rate is Fed Funds of 4.50% less PCE of 2.3%, or 2.20% and the real rate using CPI of 2.4% is 2.10%.  Since 1970, Fed Funds has exceeded PCE by .60% and CPI by 1.00%, with a differential of .40% between the two inflation measures.  More recent studies put the differential at .50%, which is why I use an implied target for CPI of 2.5%.  Many economic researchers, including Taylor, place the real Fed Funds equilibrium rate at 1.00% to 2.00%.  Studies in 2014 put the equilibrium rate at 0.00% when GDP growth was lagging potential badly.

The Fed’s projected GDP in the next three years is well below potential, especially due to the effects of high government debt-to-GDP at 120.9% in 1Q25.  When this ratio is greater than 90% for an extended period of time, as it has been since 2009, growth will be harmed in relation to potential by one-third.  We can assume potential is +3.0% plus.  So why is the Fed above the real range of 1.00% to 2.00% and not closer to 0.00% to 1.00% when growth is so weak?  Coupled with continuing QT keeping higher yields on mortgage-backed securities, and thus mortgage rates, it’s hard to come up with an answer.  It seems that Powell and his FOMC dozen are late again…just as they were in September, 2024 when Fed Funds of 5.50% produced a real rate of 3.20% compared to PCE then of +2.3%.  A 3.00% real rate?  Given the lag in Fed policy of six to nine months, it makes sense that their tight policies have weakened growth now.

There are many reasons why inflation would fall rather than rise.  Falling energy costs and the shift back to fossil fuels will lower costs compared to expensive “green energy,” although we will see volatility in oil prices as we did last week with the Iran-Israel conflict.  The weaker economy, which could be exacerbated by tariffs affecting consumer and business spending, lower federal spending, restrictive Fed policy, and high government debt-to-GDP levels will all put downward pressure on inflation.

Stocks and Bonds Go Wild

We started the second quarter with President Trump’s “Liberation Day,” where he rolled out extremely high tariff rates for all countries.  These were quickly figured out to be trade deficits to total exports, not actual tariff rates.  But the shock was there on April 3rd and April 4th, which were two of the most horrible trading days in memory, with the DJIA down -9.5%, S&P 500 -10.8%, and Nasdaq -11.8%.  It was a pure-panic market collapse, not a crash, but we didn’t know this until later.  It seems all of Wall Street shorted the market, only to be whipsawed on April 9th by Trump’s announcement of a delay of 90 days in tariffs to allow for deals to be made, although he kept in place a minimum tariff of 10%.  The pause was recommended publicly by Jamie Dimon and Bill Ackman and Trump listened.  Short covering rallies are the most fun to watch, with the DJIA +8.0%, S&P 500 +9.5%, and Nasdaq +12.2%, which were some of the best trading days ever.  Volatility, or the VIX, peaked at 52%!  By May 13th, all of the price meltdown was recovered.  Today, June 27th, the S&P 500 and Nasdaq have recovered to above their all-time highs.

Bonds experienced volatility of their own during April and acted in their traditional role of being a flight-to-quality trade.  The 2-year Treasury hit a low of 3.54% on April 4th, went back up to touch 4.00%, and today is at 3.74%.  The 10-year Treasury hit a low of 4.14%, went back up to 4.57%, and today is at 4.28%.  Bond vigilantes woke up and began looking at the size of deficits, especially after Moody’s downgrade of the US credit rating from Aaa to Aa1 on May 16th; the vigilantes pushed the 10-year yield to 4.57% and the 30-year yield above 5.00% that day.  The problem is that Moody’s action comes 14 years after S&P took the same action on August 5, 2011 from AAA to AA+.  Perhaps the assorted calculations of the “One Big, Beautiful Bill’s” deficit size spooked the bond market.  It was passed by the House on May 22nd and sent onto the Senate. Some of the deficit will be offset by DOGE spending cuts of $160 billion.  Of course, the CBO “scoring” is typically suspect, not allowing for increased revenues.  Nonetheless, the vigilantes are watching, but despite their best efforts, rates are drifting lower.

Tariffs

Suddenly everyone’s a tariff expert.  I’ve seen some outrageous projections which seem skewed toward increased inflation.  But what if the tariffs affect spending enough to slow down growth?

The US has been experiencing large trade deficits, especially with China, for over 20 years.  President Trump pointed out that the US has suffered from unfair trade practices.  We charged tariffs of 2.7% on average in 2024 to other countries and they charged us 6.7% plus VAT taxes plus manipulated their currencies.  His goal is to wipe away the unfairness and increase tariff revenue without increasing inflation.  But clearly the uncertainty has rattled both stock and bond markets, not to mention the Fed.  The meltdown in stocks on April 3rd and 4th caused a decline in market capitalization of an estimated $6.4 trillion, which has since been recovered.  But why the huge reaction when US imports are $3.3 trillion, or only 14% of the economy.  Many trillions of dollars of commitments have been accepted by President Trump for domestic investments in manufacturing plants and equipment from companies all over the world.  Tariffs provide incentives for manufacturers to produce here in the US.

We are in the process of readjusting our economy to increase manufacturing and production here at home, using our natural resources- oil and gas domestically and minerals from the deal with Ukraine.  Tariffs are not generally inflationary as producers absorb some of the tariff costs and consumers can often substitute cheaper domestic goods for imported ones with tariffs.  The shades of the Smoot-Hawley Tariff Act of 1930, which raised tariffs from 13.5% to 20%, loomed over the markets before fading away.  If you want to argue about the 1930s, start with the Fed, who kept rates too high during those years and added to the severe decline in GDP.

Thank You, President Harker

I wanted to give a huge thank you to outgoing Philly Fed president, Pat Harker, who served our region better than any other Fed President, in my opinion.  I wish there was not a term limit.  I thank you for your wisdom, insights, and dedication to all of us who live and work here.  All the best to you!

Happy Events

April wasn’t all crazy.  We witnessed Rory McIlroy achieve the Grand Slam by winning the Masters on April 14th.  The Eagles visited the White House on April 28th as part of the national recognition of their great Super Bowl LIX win on February 9th.  For me, retirement is about happy times and we spent a few days at Hershey Park this month and this summer Paris is calling my name.  I will again climb the 350 steps to the Abbey at the top of Mont Saint Michel in Normandy.  I recommend that you also make plans for happy times!

I appreciate your support!  Thanks for reading!  DLJ 06/27/25

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy recently retired from Penn Community Bank where she worked since 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.

Disclaimer: This publication is provided to you solely for educational and entertainment purposes.  The information contained herein is based on sources believed to be reliable but is not represented to be complete and its accuracy is not guaranteed.  The expressed opinions, views, and estimates are those of the author as of this date and are subject to change without notice.  The author cannot provide investment advice but welcomes your comments.

Guest Post: Financial Markets & Economic Update 4Q23 by Dorothy Jaworski

Financial Markets & Economic Update - Fourth Quarter 2023

  

Summer Update

On this warm October day, I am staring at my Bloomberg screen, still heartbroken over the Phillies Phailure.  Now, all of our hopes ride with the Eagles.  Interest rates are all elevated, with the 2-year Treasury yield at 5.01% and the 10-year at 4.85%, which is up by over 100 basis points since June 30, 2023.  Most of the inversion between these two yields is gone.  The 3-month T-Bill is at 5.45%, so there remains some inversion to the 10-year yield.  Stocks are down again today and have been down all week.  Gold has reclaimed $2,000 per ounce and its status as a safe haven, with all that is going on with war in the Middle East.  Too bad Treasuries are not as much of a safe haven.  Markets sent Treasury yields higher in reaction to huge deficit spending and a Federal Reserve intent on pushing rates higher, keeping them “higher for longer” with large price risk as everyone has learned for the past three years.

Some argue that, because we saw real GDP rise by +4.9% in 3Q23, that the economy is robust and strong.”  Yes, it was for that quarter, but, if you read my last newsletter, the summer of fun meant that quarter would be stronger, as the last stages of pandemic pent-up demand saw excess savings spent with abandon.  YOLO- You Only Live Once!  People traveled on vacations with their newly renewed passports, enjoyed entertainment (can you say Taylor Swift and Barbie?), and ate out at their favorite restaurants.  Now the harsh reality will sink in and El Nino is sure to give us a cold winter.  Inflation is still elevated, even while it slowly declines from 2022’s peaks.  We will continue to fall toward the Fed target of 2.0% but it takes time and patience.

 

Index of Leading Economic Indicators

I just finished studying a chart of the year-over-year changes in the index of leading economic indicators, or “LEI,” going back to 1960.  For every period of sustained y-o-y declines in LEI, recession has either begun or followed quickly.  The LEI fell again in September, 2023 by -.7% and is down y-o-y by -7.8%.  The index began to decline in March, 2022 (no surprise that the Fed started tightening that month), and has been down for 18 months in a row; the LEI is down -11.1% since March, 2022 to 104.6.  In July, 2022, the LEI began to decline y-o-y, yet we have not been in recession or see one imminently.

The chart showed eerily similar patterns of declines in 1990 and 2000-2001.  Unsurprisingly, the largest declines occurred starting monthly in March, 2006 and on a y-o-y basis in September, 2006 and continued to November, 2009.  The largest monthly decline took place in May, 2009 at -27.2% y-o-y with the index reaching a low of 75.7.  We all remember the Great Recession, which began in 2007, but the LEI knew it as early as March, 2006.  This time will be no different and patience is required.

By the way, there are sister indices to the LEI, the coincident for current conditions and the lagging index for 6 to 9 months ago.  Both are relatively stable, indicating the economy has been and currently is okay.

  

Are Rates Restrictive?

Do you remember what it means for Fed policy to be “restrictive?”  It means getting the Fed Funds rate above inflation so that a positive number, or real rate, would result after subtracting inflation from the Fed Funds rate.  Every inflation measure that I track closely is below current Fed Funds of 5.50%, resulting in restrictive rates of varying degrees.

Fed Funds is 1.40% over September’s annual core CPI of 4.1% and 1.80% over annual headline CPI of 3.7%.  Fed Funds is 3.10% over 3Q23 core PCE of 2.40% and 2.60% over the PCE deflator of 2.9%.  Fed Funds is 1.10% over the annualized 3Q23 employment cost index of 1.1% and is 1.30% over the most recent data for wage growth of 4.2%.  So, yes, rates are restrictive.  And the FIBER leading inflation index and M2 money supply are both falling year-over-year, by -1.2% and -3.6% respectively, so inflation will continue to trend downward.  Fed Chairman Powell stated “You know restrictive only when you see it.”  Well, you be the judge… I believe that the Fed is done raising rates; they just don’t know it yet.  And looking ahead to the 2024 Presidential Election, they clearly would want to be on the sidelines.

 

Risks to the Economy

We were growing real GDP 2.1% to 2.7% for the four quarters ended 2Q23 and then experienced an outlier of +4.9% in 3Q23.  Yeah, the summer of fun.  Consumer spending accounted for one-half of GDP.  Businesses built inventories adding 1.30% to GDP.  Housing made a small positive contribution after a string of negative quarters.  Much of the data was weak, so it’s doubtful that we can keep repeating this pace.

The risks are many.  We have an aggressive Fed threatening more rate hikes.  Long-term interest rates just increased by 100 basis points in the past few months, in a time when inflation is falling.  Government spending and huge budget deficits are upsetting investors.  Mortgage rates are now close to 8.00%; affordability is at its lowest point since 1989, according to the National Association of Realtors.  Low inventories of homes has hurt sales.  No one will give up their 3.00% mortgage for an 8.00% one.  Usually high interest rates would put a damper on home price increases and we might expect prices to outright decline.  But not in this market.  Prices are stubbornly high and rising, with August y-o-y increases of +2.2% for the Case Shiller 20, +2.6% for Core Logic, and +5.6% for the FHFA. 

China is having its own economic troubles and supply chains could suffer again.  And what a time for the UAW to go on strike- demanding outsized pay raises and slowing production at the Big Three automakers and hurting their suppliers.  Thankfully, they appear to be close to agreement.  According to Cox, one-half of Americans cannot afford a new car.  Sales will be affected by both the strike and affordability.

Some banks have tightened credit and there is also weakening demand for bank credit as small businesses are hurting from higher costs and higher interest rates.  Huge amounts of government debt and business debt, including commercial real estate, are repricing over the next two years at higher rates.  Real bank credit (excluding inflation) has been falling for the past 12 to 24 months.  Generally, GDP would be falling in this situation.

Finally, one more thought about the Fed.  They have raised interest rates by 5.25% since March, 2022, let almost $1 trillion of their bond portfolio mature without replacement and allowed M2 money supply to decline y-o-y starting in December, 2022 for the first time since the 1940s and at the fastest pace since the 1930s.  September was -3.6% and July and August were both -3.9%.  Leads and lags for M2 changes are thought to be 12 to 18 months.  The Fed has been pushing inflation lower, but, if they really believed in policy lags and looked at the LEI and M2 y-o-y declines, they would ease right now.  I wonder what Maestro would do.

 

Where is Recession?

Be patient.  It will come.  High interest rates- both short-term and long-term- an aggressive Fed, the LEI, and an inverted yield curve are all precursors of a recession.  The yield curve is less inverted than it was earlier this year, due to large increases in longer-term rates.  This actually plays into the recession forecasts.  The inverted curve is the precursor of recession, but it is the re-steepening of the yield curve that is the sign of imminent recession.

I mentioned the LEI earlier.  It has been falling on a monthly and y-o-y pace that is always associated with recessions- big ones and small ones.  Do not ignore this and other indicators as they always teach us something.

M2 is falling.  Inflation is responding by falling.  It was the massive increase in M2 in 2020 and 2021 (and beyond!) along with pandemic-related supply chain disasters that led to inflation.  It will be the decline in M2 that reduces it.  The FIBER leading inflation index is still falling on a y-o-y basis, and is currently -9.2% from its high in March, 2022.

The major surveys, including ISM, S&P, and the local Philly Fed, continue to show weakness in terms of current conditions and outlook.  Inflation has tamed down in most of them.  Stock markets have been very volatile and are mostly down since the summer months.  Are they all sensing that the summer of fun is over?  Profits have been mostly positive for the 3Q23, but probably not enough to make the past 12 months positive.  We shall see.

 

I was in Switzerland in July and I regret that I did not have the time to visit CERN, the home of the Large Hadron Collider.  The LHC has been running heavy ions through the system for the past five weeks, ending on October 30th.  What will we learn from this?  Maybe the LHC really is changing our world, turning economics upside down, and leading to outcomes that are unexpected given our knowledge of the past.  As always, thanks for reading!

 

D. Jaworski 10/28/23

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with Penn Community Bank and its predecessor since November, 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.

Guest Post: 2nd Quarter 2022 Financial Markets and Economic Update by Dorothy Jaworski

 

Financial Markets & Economic Update -Fourth Quarter 2022

What a year 2022 has been!  Thanksgiving is this week and we can all be thankful for our families and friends.  May we all enter this holiday season joyously.  We are closer to the end of inflation and employment is still strong, with job openings exceeding unemployed persons by several million.  We’ve seen tremendous market declines in both stocks and bonds, volatility, and a Federal Reserve who is raising interest rates at a breathtaking pace.  Short-term rates have risen from .25% to 4.00% so far and the Fed says they are not done yet.  Housing markets have suffered, with mortgage rates climbing up to 7.00%.  We are thankful that there has been some recovery in stocks and bonds over the past two weeks.

My biggest concern with the Fed is that they are continuing to pile on outsized rate hikes and are not spacing them out to consider the typical six- to nine-month lag in their policy moves.  As Milton Friedman famously wrote: “Monetary policy affects the economy with long and variable lags.”  Thus, the Fed needs to anticipate and assess the damaging effect of large rate hikes on the markets and on economic activity.  I was rejoicing when I saw their latest FOMC statement from early November, which included wording about the pace of future hikes (they tell us there will be more): “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.”  Maybe they will wait and assess the effect of the four big .75% hikes in June, July, September, and November; based on lags, we are not fully seeing their impact yet.  As Philadelphia Fed President Harker said recently: “Inflation is known to shoot up like a rocket and then come down like a feather.” 

The Fed is raising rates to reduce aggregate demand to fight off inflation, even though they themselves waited too long to raise rates and inflation began as a supply-chain-driven problem, when production of goods could not keep up with new demand.  The downside to all of the rate hikes is that we face a high risk of recession in 2023.  Consumer spending and business inventory financing will be hurt by higher interest expense and it will take a toll on savings and corporate margins, respectively.

 

Inflation

Milton Friedman also wrote that “inflation is always and everywhere a monetary phenomenon.”  Money supply, as measured by M2, was growing in 2020 by over 20% year-over-year and in 2021 by 12% to 20% due to the Fed injecting liquidity through its bond buying program of $100 billion per month and the federal government passing continued Covid-19 relief bills, placing trillions of dollars into the economy.  It is no wonder that demand surged.  And M2 growth started 2022 at 12%, with the Fed still buying its $100 billion of bonds through the month of March, even though they knew inflation was a serious issue.  And now M2 growth is down to 1.3% in October, which is below the range we experienced during the prior 10-year recovery of 3% to 5%.  The Fed has reduced their balance sheet by $900 billion so far in 2022; a decline of $1 trillion is the equivalent of 1.00% of tightening.  Remember this “hidden tightening” as you see the rate hikes piling up.

Rates have risen since March 2022.  The CPI peaked at +9.1% year-over-year in June and is now +7.7% in October, which is a good declining trend but still too elevated.  The Fed’s preferred measure is the PCE deflator, which was +4.2% in the third quarter compared to +7.3% in the second quarter and +7.5% in the first quarter.  The core PCE (excluding food and energy) has fallen to 4.5% in the third quarter from +5.6% in the first quarter.  The CPI and PCE measures differ in the amount of housing and shelter used in the calculation; CPI has a weight of 42% for housing and 32% for shelter, which the PCE indices use 15% to 16%.

I mentioned earlier that the Fed was raising rates to reduce aggregate demand.  They cannot control the supply side, which has been particularly hard hit for goods from China, as their Zero-Covid policy locks down entire cities.  More analysts are pointing at energy policy as one of the main contributors to inflation, when government stopped drilling expansion of oil and natural gas and distribution networks such as the Keystone Pipeline to pursue a “green” agenda full of batteries, solar power, and wind.  The problem is that we are not ready as an economy to turn on a dime away from fossil fuels and businesses are reluctant to make the necessary capital investments to drill for more oil.  When Russia invaded Ukraine last February, the price of oil shot up to $110 per barrel in June but has since returned to pre-invasion levels at $77 per barrel.  Transportation costs have increased leading to an increase in the price of just about everything, especially food, where prices are dependent on the cost of goods getting to their final destination.  Food and energy prices have been damaging to family budgets.

 

Leading Indicators

How are the leading indicators doing?  There is some good news for inflation but worse news for the economy.  The index of leading economic indicators has continued to fall further, with October at -.8%, following September’s -.5%, and is now down for eight consecutive months.  This indicator accounts for the lag in Fed policy and projects six to nine months in the future. 

The FIBER leading inflation index also continues to fall, but this decline is good news for inflation.  The index turned down in May 2022 and is now -8.0% in October, following -5.8% in September.  This index also looks out six to nine months.

Stock markets have declined most of the year before stabilizing recently.  The Dow Jones and S&P 500 averages are down -6% and -16% respectively.  Nasdaq has been the worst performing, at -28% year-to-date.  Stocks are a forward-looking mechanism, based on projections of corporate earnings.  PE ratios 12 months forward are currently at 17.5 times for the S&P 500, which is slightly over the historical average of 16 times.  Bond markets have also declined from the relentless Fed interest rate hikes, with the Treasury aggregate price index down -12.7% in 2022.  The Fed said they will look for financial stress and may be getting their wish as we have witnessed crashes in Bitcoin and other “digital coins” and the sudden collapse of the FTX exchange.

Housing is leading the way lower as one of the most rate sensitive sectors of the economy.  Mortgage rates soared to above 7%, up from 3.25% at the beginning of the year; the higher rates have backed down slightly in the past couple of weeks but are still contributing to a fall in affordability.  New home sales surprised to the upside in October, but existing home sales keep falling.  Inventories remain tight for existing homes and much higher for new homes.  Commercial real estate is also under some pressure with projects proving uneconomical at higher borrowing rates.

Consumer savings rates are down to 3.1% in September as consumers dip into savings to afford higher priced goods.  Consumer credit has continued to rise at a time when credit card and borrowing rates are all up dramatically.  These signs, as well as personal income that has not kept up with inflation, are ominous for the consumer.  Labor markets have held up well so far but we are starting to see cracks.  Fed Ex, Amazon, and many technology companies who are dependent on consumer spending are cutting costs and laying off employees.  And they are doing this right before the holidays.  Employment is a lagging indicator and its weakness has been shown in fewer payroll jobs each month, with October at +261,000, but household employment declined by -328,000 jobs, pushing the unemployment rate up by .2% to 3.7%.

Finally, the Treasury yield curve is now inverted at both critical points.  The 10 year to 2 year Treasury spread is -.76% today and the Fed’s favorite measure, the 10 year to 3 month spread is at -.57%.  An inverted yield curve is a historically reliable indicator of future recession by six to 12 months on average, although it may be much longer.  In 2023, we will be there.  Long-term Treasuries will be seeing the recession first and typically will decline before short-term rates, which is happening now. 

 

The Outlook

NBER will declare a recession when four conditions are met:  falling production, falling real personal income, falling real business sales, and rising unemployment.  The first three conditions are very weak.

The Fed has acknowledged cumulative effects of rate hikes and lags in policy, but increases of nearly 400 basis points in nine months in a 2% (at best) economy cannot be good.  Recession probability is now very high for 2023 and will get higher if the Fed continues to increase rates.  There are signs in leading indicators, business surveys such as ISM, S&P, and Philly Fed, and actual reports that inflation is declining.  Unemployment should increase slowly from layoffs, hiring freezes, and cuts in job openings.

The yield curve is inverted in both important spread measures- the 10 year-2 year and the 10 year-3 month, and history tells us that recession follows inverted curves with a lag.  Government debt remains high, at $31.3 trillion currently, or 120.5% of GDP.  Remember, debt levels greater than 90% put pressure on GDP, leaving it at subpar levels.  GDP is about even to up slightly for 2022, after negative first and second quarters and a surprising increase of 2.6% in the third quarter with another increase possible in the current quarter.  I don’t expect better growth in 2023, and I don’t think the Fed does either, but they won’t say so.

 

“It is worth remembering that it is often the small steps, not the giant leaps, that bring about the most lasting change.”  Queen Elizabeth II

 

Thanks for reading!  D. Jaworski 11/23/22

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with Penn Community Bank and its predecessor since November, 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.