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 and Economic Update-First Quarter 2025

- By Dorothy Jaworski

We made it through the long, cold winter.  There were days it was so cold I did not want to leave my house.  Even President Trump’s inauguration on January 20^th was moved indoors to the Capitol Rotunda because of wintry temperatures.  We suffered through the cold but had very few snowstorms as they seemed plentiful south of Philadelphia and basically missed us.

The first quarter of 2025 was one of a lot of excitement- a glorious run to a Super Bowl win by the Eagles, a new President and his whirlwind actions, an AI surprise from China, on and off again tariffs, a boring Fed, DOGE and government spending cuts, imaginary inflation fears, and stock market drama.  On the horrible side, Los Angeles experienced its worst wildfires ever in January, which destroyed 16,300 buildings, including 13,000 homes, killed 29 people, and displaced 80,000 in the Pacific Palisades and Eaton fires.

Undoubtedly, the Eagles 40-22 win over the Chiefs in the Super Bowl was the highlight of the quarter.  The excitement built with every playoff game and the Eagles performed at a high level.  Acquiring Saquon Barkley changed this team.  Jalen Hurts, the O-line, and receivers AJ, Devonta, and Dallas outperformed, and we owe much respect to the defense!  An estimated 1.5 million fans turned out for the parade.  As Nick Sirianni said, “You can’t be great without the greatness of others.”  Now, all eyes turn to the Phillies.  A long, hot summer will determine if they can challenge the World Series LA Dodgers for MLB’s crown this fall.

Stocks and Bonds

It feels like we’ve been on a roller coaster when it comes to the markets this quarter.  We rallied for much of January until the 27^th, when we received the DeepSeek AI announcement that a Chinese firm developed their own AI model for $6 million.  What?  Not billion?  It was chaos in the tech sector.  Nvidia and Broadcom, known for their AI chips, each fell -17% for the day, with market cap losses of -$587 billion and -$195 billion, respectively.  It’s estimated the whole AI market lost $1 trillion that day.  If China could develop technology so cheaply, why would our companies spend billions of dollars?  In a wild frenzy, millions of people downloaded DeepSeek AI.  They didn’t learn from TikTok?    Well, it wasn’t long before we discovered the truth; Microsoft reported that DeepSeek was copied from Open AI’s ChatGPT through improper use of an Open AI distillation tool.  The intellectual theft by China continues.  The markets soon recovered a lot of the losses.

Prices at the end of January seemed to hold up pretty well, but volatility and sell-offs took over in February and especially March.  In those two months, the DJIA fell -6.6%, the S&P 500 fell – 7.6%, and the Nasdaq fell -11.7%.  Gone are the new handles I wrote about last quarter: DJIA 45,000, S&P 6,000, and Nasdaq 20,000.  The media narrative turned to trashing tariffs and daily claims of recession and inflation that have rocked the markets.  I will discuss tariffs shortly.

Bonds rallied overall during the quarter with yields on the 2-year to 10-year Treasuries falling by -28 to -33 basis points.  Yields spiked in January, with the 10-year reaching 4.81%, before falling to around 4.25% now.  The yield curve briefly inverted again at the end of February (10-year minus 2-year) at – 8 bps but since has returned to positive at +34 bps.  The 10-year to 3-month spread is generally flat.  By the way, gold has rallied to new highs at $3,085 per ounce, up an astounding +42.6% in the past year, oil prices are at $69 per barrel, down -16.5% from last year, while AAA gas prices are at $3.16 per gallon, down -10.7% from last year.  Let the energy price declines begin.

 

Trump and Policies

Rarely have we seen a Presidency start off with so much action.  President Trump and his Cabinet have worked quickly to enact his policies and campaign promises on stopping illegal immigration, securing the border, and deportations, lowering income taxes for individuals and businesses, reducing prices, examining and cutting government spending and staff in every agency, with DOGE doing the analyses for the departments.  (To date, DOGE has identified $130 billion of savings and cuts, with a goal of many times this amount),  Other policies include enacting tariffs- both as a negotiating tool and to increase revenue to equalize the trading with other countries, using our massive oil and gas reserves to increase energy production, improving economic growth, and working to end the endless wars in Ukraine and Gaza.

So far, he has had success on the border and on the business side- securing almost $2.8 trillion of commitments from large US and foreign corporations to build and manufacture products here in the US over the next few years.  Oil and gas drilling is back and new leases are being sold once again.  Trump feels that lowering energy prices can have a cascading effect to lower prices of almost all goods.  Growing the economy, increasing private sector jobs, not government ones, and increasing real wages are top goals.

Tariffs and Taxes

The media also developed a recession narrative during the first quarter, even though few, if any, corporations mentioned recession during their first quarter earnings calls.  But suddenly it’s a big narrative.  The Fed played into this with their quarterly projections in March and lowered their GDP projections to +1.7% to +1.8% in 2025 and 2026, respectively, from above +2.0% in the prior projections in December.  Yet they are only lowering rates twice this year- the same as their last projection?  The Atlanta Fed GDP Now estimate for the first quarter was -2.8% as of March 28^th, even though they admit the estimate is not incorporating foreign trades of gold properly.  Be careful what you wish for; recessions are often self-fulfilling prophecies.  It’s ridiculous. 

The tariff situation has been very volatile since Trump first started announcing them in February.  He used some as negotiating leverage, some to protect US industry (autos), and some to level the playing field with reciprocal tariffs to just make trade fair.  The media narrative is that tariffs are inflationary.  I disagree.  If spending occurs on products with higher tariffs with higher prices, then less spending will occur on other goods with lower or no tariffs and those other goods’ prices will fall.  Prices tend to adjust throughout the economy.  If high tariffs depress demand, those manufacturers likely will lower prices.  Of consumers’ purchases currently, about 15% is on imported goods.  The Fed and NBER both studied the effect of Trump’s first term tariffs and found no effect on inflation, which continued to run below the Fed’s target of 2.0% then.  Tariffs do not cause inflation; as Milton Friedman taught us, “inflation is always and everywhere a monetary phenomenon.”  Even Chairman Powell knows this and called the effects of tariffs “transitory.”  (oh, no, not that word again!).  Despite knowing the results of studies on tariffs, he said he was “uncertain” of their impact.  Guests on Bloomberg guests on the day of the Powell press conference said “Why are we hanging on every word Powell says, when he keeps saying he doesn’t know?” 

Bur mark my words, once Congress passes the large tax bill making the Trump tax cuts of 2017 permanent, increasing the SALT deduction cap, lowering the corporate tax rate from 21% to 15%, putting in business deductions for accelerated depreciation, lowering individuals’ tax brackets, and including no tax on social security, tips, and overtime, the narrative about recession will quickly disappear. 

What About Other Indicators?

Here are some of my favorite indicators; watch them and you will know what’s happening:

-      Leading economic indicators, or LEI, continue to be weak.  February was -.3%, January was -.2%, and December was -.1%.  Of the past 33 months, only two were positive:  March, 2024 and November, 2024.  The Conference Board restated the index with benchmark revisions and it’s back above 100 (2016 levels) at 101.1 in February.  No surprise here.

-         Real GDP was +2.4% in 4Q24 with nominal GDP at +4.8%.  Real GDI was +4.5%; the average of GDP and GDI was +3.5%.  As mentioned earlier, the Atlanta Fed GDP Now 1Q projection number is -2.8%.  They publish it even though they state they are not including foreign trade in gold correctly.

-   M2 year-over-year growth in both February and January was +3.9% and December was +3.8%.  Friedman taught us that growth in the money supply should approximate nominal GDP growth, which is currently at +4.8%.  They are catching up and this is probably why they are cutting back on QT, their bond selling program.  After a period of decline in y-o-y M2 from December, 2022 to February, 2024, M2 growth has steadily ramped up.

-     Inflation.  Here’s the rundown.  It’s not so terrible.  PCE 4Q24 +2.4%, core PCE 4Q24 +2.6%, PCE February +2.5%. core PCE February +2.8%, CPI February +2.8%, PPI February +3.2%.  The Fed target of +2.0% is on headline PCE; CPI is +.5% higher with +2.5% as an implied target.  The 5-year Treasury Tips spread is 2.67%; the 10-year TIPS spread is 2.38%.  The final March survey of the University of Michigan showed the 5-year inflation expectation was +5.0%, but sorry, they are wrong.

-     Unemployment.  The BLS benchmark revision reduced -589,000 from reported jobs in 2024, not the original -818,000 projected last August.  The unemployment rate was 4.1% in February compared to 4.0% in January.  Unemployed persons are 7,052,000 and the pool of available workers is 12,945,000; both have been on the rise in recent months.

-        The Fed has been boring lately.  We know they are afraid to change rates, even though Powell says they are “meaningfully restrictive.”  The Fed is uncertain what tariffs will do, uncertain what inflation will be (their projections from March are outrageous- they do not hit the 2.0% PCE target until 2027!  What?!), uncertain what GDP will do (of course, they lowered it below +2.0%).  Powell kept saying they are “uncertain.” “it’s hard to tell,” “they just don’t know,” and “we’ll see what happens.”  Wow…where does that leave the rest of us?

I feel like I’ve gone on longer than usual this quarter, so I’ll wrap it up here.  I just got back from a wonderful week with great friends in Palm Beach County, Florida.  Sorry, we had no Trump sightings.  I’m looking forward to more traveling in the second half of this year.  Isn’t that what retirement is all about?  Stay tuned!

I appreciate your support!  Thanks for reading!  DLJ 03/28/25

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 all of your comments.

Guest Post: Financial Markets and Economic Update-Fourth Quarter 2024

 Drones

On the night of December 12^th, I saw reports from friends that they were personally seeing (and some videoing) the drones that have been filling the skies of New Jersey and Pennsylvania.  Their reports came from Doylestown, Willow Grove, Perkasie, Phoenixville, and Conshohocken.  Countless reports were coming in from the Lehigh Valley and the Poconos of large drones flying in formation and hovering in place.  Our government has no answers about the drones that were first reported flying in New Jersey on November 18^th.  They are dismissing the reports, saying people are seeing planes (even though they are hovering). and saying there is no risk.  We can bring the drones down (safely with technology that they use in Europe to bring down drones at soccer games) and see what they are and what’s on board.  Very strange indeed.  Because we are not bringing them down, it makes me think that they are government assets, potentially scanning for radiation, according to one corporate executive who manufactures drones and identifies what he thinks is the exact make and model of drone.  Are they scanning for radiation, spying for the Iranians or Chinese, or just crazy operators who like to fly drones at night?  We don’t know because our government won’t tell us.  Stay tuned!

Instead of speculating, I decided to wait and see what the Federal Reserve did with rates December 18th.  They lowered the Fed Funds rate by .25% to a range of 4.25% to 4.50%. as expected, and I believe they made up their minds long ago.  By the Chairman’s admission, they are still restrictive in policy.  I think they don’t want to weaken employment or the economy before our new President takes control in January.  By the way, the Trump team is concerned that inflation is not falling and are not calling for rate cuts.  The team’s arrival cannot come soon enough.  The Fed also released their quarterly projections, showing they think GDP will decline from 2.5% in 2024 to 2.1% in 2025 and they show an unemployment rate that rises to 4.3% and stays there.  The surprise is that they show PCE inflation not dropping fully to the 2.00% target until 2026.  We are so close, but why are we waiting two years?  Why?  Stock markets reacted very badly after the news of the rate cut and Powell’s press conference.  The Dow was down over 1,000 points to close in negative territory for the tenth consecutive day.  Ugh, another overreaction.

Inflation

The decline in the year-over-year inflation rates has stalled in the past few months.  The biggest declines came during the period when the Fed was allowing the M2 money supply to outright contract on a y-o-y basis.  That stopped this past April and M2 has been slowly growing ever since.  Does that mean that the Fed should not lower rates?  No, the Fed was overly restrictive when Fed Funds was at 5.50% and they are still restrictive at 4.50%.  Inflation was a critical issue this election cycle.  People are feeling the effects of cumulative inflation, up 20% since early 2021, and high prices and they need strong wage growth (on a real basis above inflation) to catch up.

It is still driving me crazy! People still refer to the CPI and say it is not at the Fed’s target of 2.0%.  It will not be!  The Fed targets PCE (and headline PCE at that) and monitors core PCE in setting their targets; the PCE and CPI indices are constructed differently with different weightings of components.  PCE covers urban and rural areas and changes weightings monthly to account for consumers substituting different goods when prices change.  The CPI covers only urban areas and weightings are adjusted once a year.  The Fed favors headline PCE and that is their target.  We can certainly use CPI but it must be adjusted to compare to PCE.

In research from November, 2017, Noah Johnson of the BLS showed analysis of the two indices.  He showed that CPI has exceeded PCE by 100 basis points over the past 50 years.  I read a research report by Bloomberg (some time ago) that showed the spread to be lower at lower rate levels and they adjusted the spread to 50 basis points for the past 10 to 15 years.  So, if the Fed target for PCE is 2.0%, CPI can be 2.5% and they still meet their target.  We are getting so close but frustratingly far away on some measures: PCE in October was 2.3% (September 2.1%), core PCE in October was 2.8% (September 2.7%), CPI in November was 2.7% (October 2.6%) and core CPI in November was 3.3% (October 3.3%).  GDP’s PCE for 3Q24 was 3.7% compared to 2.8% in 2Q24, sharing a 3 handle with core CPI, so that is worrying people.  The other PCE measures are trending so slowly to 2.0%.  People worried that CPI rose in November, but one of the main causes was a large increase in egg prices due to Avian bird flu.  Should the Fed change rates based on egg prices?

Based on a Fed Funds rate of 4.50% and inflation measures, is the Fed tight/restrictive?  Yes, certainly they are based on a spread to PCE of 2.2%, core PCE of 1.7%, CPI of 1.8%, and core CPI of 1.2%.  Comparing Fed Funds to nominal GDP in 3Q24 of 5.0%, the spread is -.5% and not tight.  Granted, when the Fed eased yesterday, nominal GDP was 4.7% prior to today’s final revision.

GDP, and Should We Look at GDI Too?

Anyone who knows me knows that I am a fan of Dr. Lacy Hunt’s writings on the Fed, rates, and the economy.  His continued research has convinced me to look at the average of two economic production measures: GDP- tracks expenditures on final goods and services produced, and GDI- sum of the income received by all those who produce the goods and services, and not just focus on GDP.   Both are contained in the quarterly GDP reports.

Real GDP in 3Q24 was +3.0%, 2Q24 was+3.0%, and 1Q24 was +1.6%.  Real GDI for 3Q24 was +2.1%, 2Q24 was +2.0%, and 1Q24 was +3.0%.  It’s a mixed picture, right?  Shouldn’t they equal?  The short answer is yes and attempts are made during annual benchmark revisions.  But the average of GDP and GDI is more consistent: for 3Q24, it was +2.6%, in 2Q24 was +2.5%, and in 1Q24 was +2.3%.  It gives a smoother picture of the growth trend, which is clearly lower than headlines for GDP would indicate.

I think the lower trend of the average of GDP and GDI is why the Fed started to ease.  The nominal average of GDP and GDI for 3Q24 was +4.5% (equal to FF), for 2Q24 was +5.1% (was .4% under FF) and 1Q24 was +5.4% (.1% under FF).  The Fed generally eases policy when Fed Funds exceeds nominal GDP, or better yet, the nominal average of GDP and GDI.

November, 2024

What a month it was!   For me personally, I went to Disney World with family and reconnected with Florida cousins.  We toasted my one-year retirement anniversary at lunch on November 8^th.  But the election dominated the news, with Donald Trump regaining the White House for a second term.  He swept all of the swing states by connecting with everyday people.  His promises on immigration, securing the border and deportations, lower taxes for consumers, seniors on social security, and businesses, improving trade with tariff strategies, lower inflation by ramping up production dramatically for oil and natural gas, cutting costs of government using DOGE, and putting an end to endless wars resonated with voters.  He has surrounded himself with businessmen and some surprising picks to run the government agencies, with a promise to cut regulations that are strangling banks and corporations.  It’s music to Jamie Dimon’s ears, although I’m a little sad that he is not part of the new administration.  He’ll continue in the role of consultant to Trump, as has been the case for many months.

Stocks rallied wildly during November at the promise of lower taxes and an improved business environment.  Bitcoin’s price exploded from 66,000 in October to 106,000 the other day, or +61% due to the Trump effect of supporting Bitcoin.  The DJIA has struggled this month, with the December 18^th  selloff the 10^th consecutive day of declines (but up 14% y-t-d), the S&P 500 and Nasdaq achieved new handles of 6,000 on the S&P (up 25% y-t-d), and Nasdaq of 20,000 (up 34% y-t-d).  Trump had the honor of ringing the opening bell on the NYSE on December 12^th.

The markets perceive improved GDP growth with less government cash flooding the economy and crowding out business, although the Fed’s projections from yesterday show a decline in GDP from 2.5% this year to 2.1% next year.  A lower budget deficit would be a welcome relief for the bond market roller coaster, where yields plunged in September upon the first Fed rate cut of .50%, only to have long-term yields rise by 70 to 80 basis points, while the short-term rates fell 100 basis points so far.  The yield curve has gone from inverted (10 yr to 2 yr and 10 yr to 3 month), to flat, to steepening very quickly.  The budget deficit for 2024 was -$1.8 trillion, or 6.1% of GDP, and was -$1.7 trillion in 2023.  The Trump goals include reducing the deficit to GDP to 3% or less.  Debt is at $36.2 trillion and interest to service that debt was $950 billion in 2024.  Debt-to-GDP is at 120.7% in 3Q24; long periods above 90% will reduce GDP potential by one-third.

And speaking of government, on December 18^th, Congressional and Senate leaders tried to jam a 1,547 page “continuing resolution” down the throats of Congress and the American people.  It was loaded with incredible spending and unrelated “perks,” such as giving a gigantic pay raise to Congress while many American people can’t make ends meet, sheltering Congress members from subpoenas (wow!), giving state and local workers an extra social security payment, allowing Congress members to opt out of Obamacare when all of us cannot, providing money to upgrade the NFL Washington Commanders’ stadium (why?), paying for the destroyed bridge in Baltimore that should be paid for by private insurance, paying $10 billion to keep a government agency in the business of censorship of conservatives for another year, and a restrictive debt ceiling.  The list goes on and on.  Elon Musk, Donald Trump, and JD Vance put an end to this outrage and back room dealing.  This bill is now thankfully off the table.  The deadline for a spending bill is December 20^th  at midnight or else the government shuts down.  Stay tuned but the American people did not vote for this…

What About Other Indicators?

We can’t forget my other favorite indicators; watch them and you know what’s fundamentally happening and what will eventually happen.

-           M2 growth y-o-y- From the Fed H.6 report, y-o-y growth in M2 money supply for October was +3.1%, September was +2.6%, August was +2.0%, and July was +1.3%.  Y-o-y growth turned positive in April, 2024 after 16 months of y-o-y declines, which hadn’t happened since 1931-1933.  Milton Friedman said M2 growth should equate to nominal GDP growth, so the Fed is still restrictive.  Dr. Hunt indicates that the rate cuts by the Fed are needed to reverse the negative and low trend growth of M2.  And don’t forget, they are still doing QT, or reducing their bond portfolio, which also drains money from the system.

-          The dollar was volatile all year.  Standing at 106.84 on December 12^th, with a low of 100.16 on September 27^th, but it is now up +5.4% from the level at December 31, 2023 of 101.33.  This is good news for fighting inflation as import prices will be lower on a relative basis and this will help to keep inflation down; however, it may not be the best news for exports.  China is experiencing deflation for the last six quarters and factory prices there have declined y-o-y for 26 months in a row, according to the WSJ and that is good news.

-          Leading economic indicators- Surprise!  In today’s release, the LEI rose +.3% for November (the Trump effect), after declining for 30 of 31 months since April, 2022 with only a small increase in February, 2024.  The index fell below 100 (100=2016) in September and November equaled that level at 99.7.  Go figure.

-      Housing- Y-o-y home prices are still increasing with Case Shiller at +4.6% in September and FHFA at +4.4%.  Average mortgage rates for new 30-year loans are 6.72% while the average mortgage rate currently on homes in the US is 3.78%.  No wonder there is no inventory on the market.  New construction continues to be slow.  Zillow showed how unaffordable housing really is- today, a salary of $106,500 is needed to buy a house at the average sale price; in 2020, that same salary was $59,000.

-   Employment- The unemployment rate in November was 4.2%, up from 3.7% one year ago.  In November, payrolls rose by 227,000 after two grim months, but household employment fell by -355,000.  Unemployed persons now total 7.14 million and the pool of available workers is 12.63 million.  Over the past year, full-time jobs have fallen by -1.34 million to 133.39 million while part-time jobs have grown by 106,000 to 37 million, with likely few benefits for the latter.  This is hardly a robust employment market.  Remember the August announcement that at least 818,000 “jobs” will be pulled out of totals for 2024 as they simply did not exist.  Perhaps that was due to the Philadelphia Fed monitoring job growth and showing that there were job losses that began in 2Q24.  This could explain the Fed rate cuts.

-     Productivity- In 3Q24, it ran at +2.2% following 2Q24’s rate of +2.5%.  Wages can rise greater than inflation targets if productivity runs close to its long-term average of +1.5%.  Currently, in November, the wage growth was +4.0% y-o-y, which is okay if productivity stays above 2.0%.

-    Crude Oil- The latest price is just below $70 per barrel, equal to where we started 2024.  If we can increase production dramatically (the goal may be an increase of 3 million barrels per day), a decline in oil prices can lead inflation lower.

 

Finally. 2024 has been a great ride.  There’s more time to travel, to write, to be with family and friends.  People ask me if I miss working.  The answer will always be yes, I do.  I especially miss my colleagues.  They probably have missed me saying throughout the year that “Christmas will be here before you know it.”   Christmas is less than a week away and I pray that all of you find time to relax and enjoy life.  I wish you all a very Merry Christmas and a Happy 2025!!!

I appreciate all of your support!  Thanks for reading!  DLJ 12/19/24

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 all of your comments.

Guest Post: Financial Markets and Economic Update- Third Quarter 2024

Financial Markets Update – Third Quarter 2024

I had a fantastic September traveling to France and Luxembourg with my sisters.  We joined my dear friend, Elisabeth, Thanks GIs Association, and other American families for the dedication ceremony of a new monument to the 11^th Infantry Regiment, who fought in the Dornot-Corny battle along the Moselle River in 1944 for their freedom.  My Uncle, Stephen W. Jaworski, was killed in action during these battles just south of Dornot.  We spent quality time with our French friends/family.  We joined Thanks GIs for lunch with the Mayor of Noveant, who surprised us with a posthumous Medal of Honor award to Stephen from the town.  It was another emotional day, and later we visited Stephen’s gravesite at the Luxembourg American Cemetery to honor him.  These were powerful, emotional events and I will always be proud to represent Stephen, our family hero.

Where is the Recession?

I’ll start this subject again this quarter by saying I believed we would get recession by now; my timing has been horribly early and wrong.  All the signals have been there for two years; the index of leading economic indicators has been down 27 of the last 28 months, consumers are using borrowing to get them through as inflation ravages household budgets, and an inverted yield curve, which is generally a precursor of recession, lasted about two years.  Interestingly, the 10-year to 2-year Treasury spread, which was -37 basis points at June 30^th, turned positive in September after 26 months and is now +23 basis points.  The 10-year to 3-month Treasury spread is still inverted, as short-term rates wait for more Fed action.  The spread was -101 basis points at June 30^th and is still widely negative at -81 points today.  Remember, it is the re-steepening of the yield curve after a prolonged period of inversion that heralds recession and Fed easing.

You wouldn’t know we have recession risk when stocks are rampaging; markets crashed for a day on August 5^th but recovered in mere days.  Year-to-date, the S&P 500 is up +21%, Nasdaq is up +23%, and the DJIA is up +12%.  But unemployment took a turn for the worse with July’s numbers, reported in August and some economists point to the Sahm Rule (recession occurs when the unemployment rate rises +.5% in a short period), with the unemployment rate at 4.2% in August being +.8% over the low in 2023 of 3.4% to say recession could be starting.  I’ve been suspicious of the fictional payroll numbers and equally unreal JOLTS report.  In August, the BLS announced that they would cut 818,000 jobs from the payroll reports of the past 12 months as part of their benchmark revision process.  It’s the largest since 2009!  The pool of available workers is high again at 12.75 million persons and the unemployed now total 7.1 million.  Full-time jobs are down -1,021,000 in the past 12 months while part-time jobs, likely without benefits, are up +1,055,000.  Payroll and household job growth has weakened considerably since July.

Gold is signaling concern as it trades at new highs, currently $2,658 per ounce.  Safe havens are not always bonds.  Anticipated slowdowns in the economies of the US, China, and Europe led to oil prices declining to $68.64 per barrel and gas prices declining to $3.22 per gallon, according to AAA.

GDP

The latest Federal Reserve projections from September for GDP are for +2% growth this year and next year, despite 2Q24 GDP being +3.0% and the Atlanta Fed GDP Now being +2.9% for 3Q24.  By the way, Chairman Powell called 2% GDP growth “solid.”  It’s sad that we have lowered our standards.  The Fed and many others believe (or maybe they hope) that we will have a soft landing.  This is a familiar refrain.  Before every recession since 1980, economists and market participants believed the economy would have a soft landing; in fact, the elusive soft landing was achieved only once since then- in 1996 by Maestro Greenspan.  More than likely, the US will experience a weak recession…if the Fed keeps lowering rates.

The world’s best banker, Chase’s Jamie Dimon, recently warned about a scenario that is worse than recession; he says not to discount the possibility of stagflation like the 1970s, with slow growth, rising inflation, and rising unemployment.  I would add that we should not discount the possibility of inflation falling far below Fed targets if they remain stubbornly tight.

The Fed

I was not surprised at the 50 basis point cut in the Fed Funds rate in September.  I’ve continually complained that the Fed Funds rate was too high.  I think it came down to the Fed regretting that they did not cut rates in July (as all hell broke loose with unemployment right after that), so they are playing catch-up.  But I ask, in what universe does a 5% Fed Funds rate make sense?  Short-term Treasury yields and SOFR rates are all in the 4s, one-year to 10-year Treasuries all have 3 handles, and very long-term Treasuries are in the low 4s.  But a 5 handle on Fed Funds?  Even bankers disagree, as the FF effective is 4.83%, toward the lower end of the 4.75% to 5.00% range.  So yes, we’re happy with the first 50 basis points two weeks ago, but there is a lot more work to do.  I think the Fed will “catch up” again and do 50 basis points in November.  That FOMC meeting occurs after Election Day, so they won’t get any political questions.  And 2025?  The Fed themselves project the rate cutting phase will continue through the year.

Inflation

Everybody hates inflation!  Thankfully, inflation continues to head down toward Fed targets, albeit slowly for some measures.  Fed targets are based on the BEA reported PCE and core PCE numbers, published monthly and quarterly.  The most recent monthly report for August had PCE at +2.2% y-o-y and core PCE at +2.7% y-o-y.  From the GDP report, 2Q24 PCE was +2.5% and core PCE was 2.8%, both y-o-y.

In terms of CPI, August was +2.5% y-o-y and core CPI was +3.2% y-o-y.  Remember that CPI historically is higher than PCE by +.5%, so 2.5% would be a good goal to have on CPI.  Core CPI is stubborn and declining more slowly than expected.  Before we celebrate too much, can you say “supply chain issues?”  We have the threat of dock workers going on strike October 1^st at ports along the east coast of the US and across the Gulf coast to Texas.  What would this disruption mean especially since there is so much need in states like Florida, North Carolina, and Tennessee after Hurricane Helene destroyed so many communities with massive rain and flooding.

Chairman Powell stated that wage growth is not contributing to inflation.  He also called the labor market “solid,” but we will forgive him for that one.  The figure was +3.8% y-o-y for August.  Remember that wages can increase in a 2% inflation target environment and, if productivity is decent (historically +1.5%), can grow +3.5% on average.  2Q24 productivity was +2.5% and 1Q24 was +.4%, making the y-t-d average +1,5%, precipitating Powell’s comments.  The wage growth percentage for August is getting closer to this goal.

The inflation narrative really is broken down into two parts:  the level of the inflation index and the marginal rate of change.  The level of CPI is up +19.7% since the end of 2020, including food +21.8%, shelter +22.7%, and energy +33.8%.  It is the level of CPI, with no decline in sight, that frustrates consumers the most.  Victory in getting the marginal change down to a low level does not reduce their grocery, housing, utility, and energy bills.  High prices have pushed consumers to turn to credit cards to take care of everyday needs; credit card balances outstanding have ballooned to $1.34 trillion with an average rate of 23%, and more telling, a delinquency rate of 9%.

Restrictive Fed

Was Fed Funds at 5.5% restrictive?  Yes!  Let’s have a look:

FF less CPI of 2.5%= 3.0%; FF less core CPI of 3.2%= 2.3%; FF less PCE of 2.5%= 3.0%; FF less core PCE of 2.8%= 2.70%; FF less nominal GDP 2Q23 of 5.5%= 0.0%; 1Q24 of 4.6%= 0.9%; FF less nominal GDP 4Q23 of 4.8%= 0.7%.

Not to be forgotten are two other key elements in this tightening cycle- QT and M2.  QT continues at a pace of $60 billion sales or runoff per month from the Fed’s balance sheet.  To date, the balance sheet is down $1.5 trillion from its peak.  It’s hidden tightening in that $1 trillion of QT is believed to be the equivalent of +100 basis points of tightening.

M2 continues its slight growth, according to the H.6 Money Stock report.  In August, M2 grew by +2.0% y-o-y compared to July +1.3% y-o-y.  Between December, 2022 and March, 2024, M2 declined on a y-o-y basis, which was the first time that has happened since 1931 to 1933.  Don’t go there; I think the Fed was trying to offset wild government spending but decided not to risk it anymore.  Milton Friedman suggested that M2 growth should equate to output, or nominal GDP.  That’s been 4% to 5%, so M2 is restrictive and far away from equilibrium.

Speaking of government spending, the deficits are out of control, at a projected -$1.9 trillion for fiscal 2024 compared to -$1.7 trillion in 2023.  Debt outstanding is $35.3 trillion, or 121.7% of GDP as of 2Q24; when the debt to GDP ratio exceeds 90% for over five years, the negative effect on GDP is about -33% of trend.  Interest expense on debt will now top $1 trillion per year, or $3 billion per day.  Ridiculous!  Given the habit of our government of printing tons of money to hand out like candy, I am afraid of what they’ll do when we have recession.  Maybe Jamie will be right.

What does it all mean?  Recession signals are around but not impacting us yet.  Stocks, bonds, and data can all turn on a dime.  Short-term rates should continue to decline, with the Fed having some catch-up to do.  Inflation is headed down, at least the marginal change part.  Long-term rates have some room to decline, which includes mortgage rates, which are about to drop below 6%- finally!  No one will move out of their home when they have a low-rate mortgage.  The average mortgage rate in the US is 3.78%, so don’t expect too much from housing.  Unemployment is the wild card.  If it keeps getting worse, the Fed will respond more aggressively.  Those affected in many states by Hurricane Helene will have a huge task in front of them to rebuild their homes, roads, bridges, and communities after last week’s flooding and devastation.  Give them the strength to do so.

I appreciate all of your support!  Thanks for reading!  DLJ 09/30/24

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 all comments.

Guest Post: Financial Markets and Economics Update - Second Quarter 2024

Financial Markets Update – Second Quarter 2024

A dream vacation!  I went with family and friends to Holland and Belgium during peak tulip season during April.  It was so beautiful and lots of fun.  We saw so many fabulous places, including Amsterdam, Kinderdijk and its windmills, Keukenhof Gardens, Brussels, Bruges, and Antwerp.  We learned how Holland keeps the floodwaters away.  It was my first vacation in decades where I did not have work waiting on my desk when I got home.   Also, my family and I got to spend three days in Hershey last week watching the excitement on the children’s faces as they moved from ride to ride and played in the water parks.  For me, this is what my retirement is all about.  That and getting consumed by Euro 2024 and Copa America soccer and of course, the Phillies.

Where is the Recession?

I think I’ve spent too much time reading and studying economics.  The time-honored indicators that so many of us review for signals of recession continue on, month after month, and yet their ability to project recession has not turned into reality.  Take, for instance, the inverted yield curve.  In July 2024, we will mark two years of inversion between the 10-year Treasury and the 2-year Treasury yields.  It is already the longest inversion on record, surpassing the 624-day inversion ending in 1978.  The spread currently stands at -37 basis points.  At times, the spread exceeded -100 basis points.  The 10-year Treasury versus the 3-month Treasury spread, which turned negative in October 2022, is now -101 basis points.  So, after 18 months to 2 years later, where is the recession?  Some say it will appear when the curve re-steepens and some say it is coming soon.

And what about the index of leading economic indicators?  For this cycle, the LEI first had a negative monthly reading in April 2022.  Other than a slight positive of +.2% in February 2024, when the Conference Board gleefully announced that there would be no recession, the index has been negative for 27 months and is down a cumulative -15.1%.  So where is the recession?  I think we have to wait.  We know the Conference Board measures three factors with the LEI, including duration, depth of the decline, and diffusion indices; but, seriously, two of three are screaming watch out below.  The same Conference Board reversed course and now says there is a “fragile outlook,” making themselves look ridiculous as the LEI continued its descent.

And what about tight Fed policy leading to weaker growth, especially if they hold rates too high for too long?  We have many examples, notably 2000-2001, 2006-2008, and 2019, when restrictive rates impaired growth and recession followed.  Between March 2022, and July 2023, the Fed increased rates by 525 basis points, with Fed Funds at 5.50% ever since.  Are they restrictive?  Yes, when Fed Funds is above inflation and above nominal GDP growth.  Note all of the following:

FF less CPI of 3.3%= 2.2%; 

FF less core CPI of 3.4%= 2.1%; 

FF less PCE of 2.8%= 2.7%; 

FF less core PCE of 3.7%= 1.80%; 

FF less nominal GDP 1Q24 of 4.5%= 1.0%; 

FF less nominal GDP 4Q23 of 5.1%= .4%.  

We’ve seen slowing from this restrictive policy but not recession.

And what of QT?  The Fed was allowing $95 billion of Treasuries and MBS to roll off of its balance sheet but reduced the total to $70 billion starting in May.  It seems to be an acknowledgement that they must reduce this restrictive policy and that easing is coming soon as money supply was being impacted too much.  But I will get to money supply later.

Parts of the economy are suffering, including housing from high rates affecting affordability, weak housing starts and a 30-year low for existing home sales with low inventories keeping home prices higher than normal.  Manufacturing is weak.  Consumer spending and retail sales are declining this quarter as people cope with high inflation, especially on food prices.  Retail store closings have escalated as sales weaken and retail theft skyrockets.  Both consumers and businesses are paying high interest rates on their increasing debt balances.  One of the components of the LEI which is up strongly is the S&P 500 stock market index, by +14.5%.  Rallies in the Magnificent 7 stocks and Artificial Intelligence’s transformational potential mean that we may not get a recession signal yet from stocks.

So there is still no recession, although I stubbornly refuse to remove it from my forecast.  Rates that are kept too high for too long will not lead to anything good.  Signals from the yield curve and leading indicators dampen the outlook.  In my mind, recession should have already happened.  So I am obviously not accounting for existential or even psychological factors that are delaying the inevitable.

Real GDP.

Chairman Jerome Powell recently called economic growth “strong” in his press conference.  I hope he was not looking at the first quarter at 1.4%.  OMG!  Or maybe he was looking at the notoriously volatile Atlanta Fed’s GDP Now projection for the second quarter of 2.2%.  It’s a sad day when GDP growth of 2% or less is “strong.”   Of course, that’s what we lived through from 2010 to 2020.  Regardless, the FOMC projection for GDP is 2.1% for 2024 and 2.0% for 2025 and 2026.

My favorite banker, Jamie Dimon, recently called his economic outlook “cautiously pessimistic.”  He has been worried for such a long time; remember when he said in 2022 that there would be a storm, or even a hurricane that would hit the economy.  I have shared this same view with him.  And interestingly, he must now be thinking about retirement, because when asked how much longer he will stay at Chase, he did not respond with his traditional “five years,” but said “less than five years.”

With recession in many people’s projections, but not appearing on the horizon yet, we have to navigate our boats as best we can.  GDP is projected at 2% for an extended time.  I think it could be lower.  If we look at out-of-control federal government spending, budget deficits, and ever-increasing debt, it is having an impact on our growth potential.  Debt-to-GDP at the end of the 1Q24 was 122.3%; studies show that debt levels greater than 90% of GDP (which we’ve had since 2010) lead to a severe reduction in GDP.  Debt service payments for the government are accelerating at an unsustainable pace.  Lower GDP means lower inflation but it may also mean lower tax receipts.  Maybe the roller coaster in Treasury yields will come to a stop and we will see lower long-term rates.  The 10-year Treasury has been quite volatile in 2Q24, starting at 4.20%, peaking at 4.65% in April, and ending at 4.35%.  The 2-year Treasury started at 4.62%, peaked at 5.01% in April, and ended at 4.72%.

Money Supply M2

The 16-month streak of declining M2 money supply has been broken, when April and May showed slight year-over-year increases of +.2% each month, following declines of -1.0% in March, -1.9% in February, and -2.2% in January.  M2 had been declining on a y-o-y basis since December 2022 and this was the first time since the 1930s where we saw M2 fall.  We are still far below the long-term average M2 growth of 6% to 6.9%, which approximates nominal GDP growth.

In the past 150 years, excluding the current 2022-2024, M2 has declined only four times on a y-o-y basis, in 1878, 1893, 1921, and 1931-1933.  These four instances led to recession/depression and high unemployment.  I’m not sure about this time, but I think it was necessary to offset the massive federal deficit spending so that inflation could fall.

Let me repeat Milton Friedman’s quote and add more to it: “Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output (GDP).”  He made this quote in 1963, referring to persistent inflation, not short-term supply shocks.  Maybe everyone will forgive the Fed and people like myself in 2021 for initially thinking inflation would be “transitory” because of supply shocks.   We were wrong and quickly realized it because M2 was growing so much faster than GDP.  Not until mid-2022 did CPI peak at +9.1% y-o-y and start its deceleration in pace.  But now think of Friedman’s quote in reverse; if the quantity of money drops more than output, should we not see disinflation?

Misconceptions about Fed Inflation Targets

The Fed’s targets for inflation of 2% apply to PCE and core PCE.  The Fed does not target CPI.  I repeat, they do not target CPI, but they inherently consider it.  Prior analyses have shown that CPI tends to exceed PCE by .5%, due to the different construction of the underlying indices.  If the inflation target is 2% for PCE, CPI can be 2.5%.  

The Fed does not target wage growth per se.  Did anyone catch Powell’s comment during the press conference in June that linked inflation and productivity to arrive at acceptable wage growth.  I’ve written about this several times; if PCE is 2% and productivity averages 1.5% (as it has for long periods of time), then wage growth can be 3.5% and can co-exist with a 2% PCE inflation target.

Employment

In my last newsletter, I wrote that I had real reservations about the employment report.  Now I feel vindicated.  In his press conference, Chairman Powell expressed the same doubts about the employment report and the birth/death ratio applied to small businesses, which accounted for over half of all jobs added in the establishment report in the past twelve months.  Since April 2023, the B/D ratio accounted for 1.9 million, or 56%, of all new jobs.  In the May 2024 report, payrolls rose by 272,000 jobs, which included 231,000 jobs added for the B/D ratio in the face of declining business formation.  It’s ridiculous.

Look at the contrast between establishment (payrolls) and household surveys since February 2024 and the number of unemployed and pool of available workers:

Payrolls May +272,000, April +165,000, March +310,000, February +236,000; total +983,000

HH survey May -408,000, April +25,000, March +498,000, February -184,000; total -69,000

Unemployed May 6,649,000, April 6,492,000, March 6,429,000, February 6,458,000; chg +191,000

Pool AW May 12,366,000, April 12,129,000, March 11,872,000, February 12,130,000; chg +236,000

The unemployment rate now stands at 4.0% in May, up from a low of 3.4% in 2023.  The payroll numbers get the headlines, with almost 1 million jobs added in 4 months, but look deeper.  Household jobs are down and the unemployed and pool of available workers (unemployed plus those not in the labor force who want a job) are growing and the unemployment rate is on the rise.   Thankfully, the unemployment rate is calculated from the household survey, not the fictitious payroll numbers.  They are almost as fictitious as the JOLTS reported job openings.  Additionally, full-time jobs are down 1 million to 133.3 million in the past year, while part-time jobs are up 1.5 million to 28.0 million.  So, you tell me, is this a strong labor market?  Should I keep recession in the forecast?

End of an Era

In June, there was another end of an era for one of our rate indices.  Just like LIBOR was kicked to the curb, now FNMA discontinued posting its historical daily required net yields for 30- and 15-year mortgages on June 3rd, claiming that many market participants didn’t use them.  But what about the ones who did?  To me, they were worth tracking as an indicator of the mortgage whole loan versus MBS market spread.  Gone is the history back to 1985, too.  Very sad.

Summer is here.  May you all enjoy wonderful dream vacations!

I appreciate all of your support!  Thanks for reading!  DLJ 06/30/24

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 all comments.