Rate Reversals

For those clamoring for a rate cut, be careful what you ask for. What matters most to the economy is the 10-year Treasury. The Fed, outside of quantitative easing/tightening, only controls the short end of the curve. Last September, when the Fed cut rates by 50bps, the 10-year T-note was at 3.7%, vs. 4.2% today. Cutting rates while inflation expectations are elevated, as they are now, can raise long rates.

Concerning CPI

July CPI was steady at 0.2% M-o-M and 2.7% Y-o-Y. Unfortunately, the all-important core measure rose from 2.9% to 3.1% Y-o-Y, the highest since 2/25, and was up 0.3% M-o-M, adding to the headache the Fed already has. This is because inflation has clearly stopped falling yet is well above the Fed’s desired level. Moreover, this report showed limited evidence of tariff effects, the impact of which is lagged.

Hobbled Housing

July new home sales were 652,000 seasonally adjusted and annualized, down 0.6% M-o-M and 8.2% Y-o-Y. Worse, it now takes builders 2.9 months to make a sale upon completion, the longest duration in over three years. Making things worse, the median new home price slid 0.8% M-o-M on top of the 3.8% M-o-M decline in June. Prices are now down 6% Y-o-Y, almost 9% after inflation.

Powell Power

The critical thing about Powell’s talk is tone. Can he really offer dovish rate guidance? Equities are at/near record highs, credit spreads are near their tightest ever, the dollar at its lowest level in years, unemployment is just 4.2%, inflation expectations are at 2.4%, well above the 2% target, and 25Q3 GDP growth is forecast to be over 2% by the FRB of Atlanta and NY. Color me skeptical.

Underlying Unease

25Q2 GDP growth jumped to 3% seasonally and inflation adjusted, up considerably from -0.5% in 25Q1. This puts 25H1 growth at 1.25%, down from 2.5% in 24H1. Importantly, final sales to private domestic purchasers, which strips out volatile trade, government spending/investment and inventory changes to arrive at underlying demand strength, slid from 1.9% in 25Q1 to 1.2%, stall speed; the weakest reading since late 2022. A September rate cut, please.

Weakening Wages

Pre-2015, wage growth was consistently higher for high-income workers than low-income ones. Starting in 2015, that began to reverse, and during Covid that new relationship was turbo-charged. Income growth for the bottom fifth of the population at times was twice as fast. Since late 2024, the old relationship has returned, with higher income earners gaining pay raises of roughly 1.5% to 2% more, a large amount, compared to the low-paid.

Excellent Equities

Despite significant policy uncertainty and slowing economic growth, equities are at record highs. Here’s why I think it’s happening. The stock market is increasingly uncorrelated with the economy due to the Magnificent Seven. The AI story has captivated investor’s imagination, and the AI capital spending surge has massively boosted GDP. Additionally, the weakening dollar has boosted corporate profits of firms with overseas revenues, and the Fed will soon lower rates.

Consumer Consumption

During the year ending 7/25, spending increased 2% for the top third of households, those earning over $120,000/year, 1% for the middle third of households, and was zero, or zilch for the bottom third of households, those earning roughly $50,000/year or less. Consumer spending is almost 70% of overall GDP and it’s increasingly being done by the better off, due to better wage growth and substantially more capital gains.

Troubling Termination

The only reason employment data revisions are noticeably larger is due entirely to low response rates by surveyed businesses. Pre-Covid, response rates on the initial survey were 80%, now they’re below 60%. By the third wave, response rates are where they were pre-Covid, 94%. Lower response rates mean larger standard errors, and larger eventual revisions. Rather than shooting the messenger, fine firms who refuse to quickly respond to the survey.

Pleasant Productivity

25Q2 labor productivity growth was strong at 2.4% Y-o-Y. While 25Q1 was a dismal -1.8%, (the only negative reading since 22Q1) the latest result returns labor productivity growth to its post-pandemic 1.8% average. Strong productivity keeps inflation down despite good nominal compensation growth of 4%. 4%-2.4%=1.6% real labor cost growth, or 2.2% using the post-Covid average. These are well below the inflation rate, suggesting little if any wage inflation pressure.

Increasing Inflation

After steadily falling since mid-2022, inflation is again rising. Last month, Y-o-Y import prices rose at their fastest pace this year, Y-o-Y wholesale prices rose at the fastest pace in three years, and Y-o-Y wholesale vegetable prices rose 39% last month. Annual inflation as measured by the CPI has now risen three straight months, all while the labor market weakens. Tariffs are starting to slowly make their presence felt.

Lost Labor

July job growth rose just 73,000, but May/June were revised down 258,000! Average May/June/July job growth is a dismal 35,000/month, the worst three-month stretch since 6/20. Worse, unemployment rose to 4.2% despite the labor force falling by 35,000 and the labor force participation rate fell to 62.2%, its worst reading since 11/22. Add rising wages, maybe because the foreign-born workforce shrank dramatically last month, and you have an unsettling report.

Credit Concern

During the month of June, outstanding credit card balances dipped $1.1 billion and that followed a $3.8 billion decline in May. Balances have now declined in three of the last four months, and over the past year credit balances have slipped $33 billion, or 2.5% Y-o-Y. This is a phenomenon we haven’t seen since spring 2021 and speaks to the cautious and frugal mentality being exhibited primarily by lower-end households.

Astounding AI

In 25Q1, Amazon, Alphabet, Meta and Microsoft collectively spent $88 billion on equipment and property (data centers, semiconductors), primarily in pursuit of their AI goals. Their spending is rising rapidly. During 24Q1 it slightly exceeded $50 billion. Annualized 25Q1 spending is over 1% of GDP, a stunning amount, more than spending as a percentage of GDP during the dotcom boom, and it’s responsible for half of 25H1 GDP growth!

Dwelling Depreciation

Home prices fell 0.34% in May, the third straight M-o-M decline. Y-o-Y price appreciation has declined from 4.7% in January, to 4.5% in February, 4.1% in March, 3.4% in April, and 2.8% in May, barely ahead of inflation. Seasonally adjusted, prices are now lower than they were in 12/24. Absent a sharp decline in rates, or a strong rise in income growth, prices are likely to keep falling.

Fed Frustrations

On one hand, the Fed sees short- to medium-term inflationary pressures building from a 1000% tariff increase, OBBBA fiscal stimulus, possibly rising wages due to manufacturing job onshoring, combined with the number of unemployed manufacturing workers available to work near record lows and exacerbated by increasingly substantial immigration outflows. On the other, the Fed also sees the labor market steadily softening. It’s a case of rising inflation vs. rising unemployment.

Tokyo Tariffs

While cinching a trade deal with Japan is good news, hold the applause. Pre-trade war, the tariff on non-agricultural Japanese imports was 1.6%, it’s now 9x higher at 15%. Consumers will eventually feel this. The deal also calls for $550 billion in Japanese investment in the US. Unfortunately, the trade deficit, which must equal net foreign investment in the US, must now rise by you guessed it, $550 billion.

Crumbling Construction

Since 2000, labor productivity has risen by 54%, during the same period output/worker in construction has fallen 8%. It’s due to a combination of fragmentation due to overregulation leading to underinvestment. Research has shown that construction firms with over 500 employees are 2x as productive as firms with 100-249 employees, 4x as productive as firms with under 20 employees. Construction firms unite; you have nothing to lose but lousy productivity.

Tariff Totals

While we can argue if households, firms, or manufacturers effectively pay tariffs, the data is in. From 1/1/25-5/31/25, California businesses paid $11.3 billion in tariffs. Texas was a distant second at $6 billion, then Michigan at $3.3 billion. 14 more states paid over $1 billion in tariffs. 11 states paid less than $100 million, with Alaska and Wyoming taking the smallest hits at just over $16 million each.

Millionaire Migration

The millionaire population totals 60 million. It rose by 685,000 last year, the US added 379,000. Unsurprisingly, they’re mobile. The biggest recipient nation of millionaire immigrants that also take on new citizenship in 2025 is expected to be the UAE with 9,800. The US follows at 7,500, then Italy at 3,600, Switzerland at 3,000, and Saudi Arabia at 2,400. The biggest losers, the UK at -16,600, and China -7,800.

Tail Tally

In 2025, Americans are expected to spend $157 billion on their pets, 62% more than in 2019. $67.1 billion will be spent on pet food/treats, $41.4 billion on veterinary care and products, $34.3 billion on supplies, live animals & OTC meds, and $13.5 billion on other. While pet food costs are up 20% since Covid, pet services like veterinary bills and grooming services are 42% more costly.