The latest on the inflationary expansion of 2026, a/k/a “Guns & Butter 2”

 

 - by New Deal democrat

Today let’s take a look at the first reads of August business activity, from the New York and Philadlephia Feds, and put those in context of our current economic and fiscal situation, which I have been describing as an inflationary expansion.

Both of those components, both the expansion and its inflationary aspects, were given further confirmation by both Fed regional districts’ manufacturing reports. 

First, here is the average of the headline number for both indices (blue) and the more leading new orders component (red):

Any number above 0 indicates expansion. For August, the headline average was 34.0 and the new orders average was 23.7. The last several months have been on par with the post-pandemic Boom in 2022. Here is further context with the long term historical graph:

Again, the past two months’ averages have been as good as the very best readings since the turn of the Millennium (as far back as the FRED numbers go). 

That’s the good news. The bad news is that inflationary pulse continued as well. Here’s the historical graph of the diffusion indices of both prices paid by producers (blue) and prices received by them downstream (red):

The current widespread pricing pressures on the incoming end, which is only partially being passed on downstream, is also as bad as at any time since the turn of the Millennium, with the exception of the post-pandemic period and the gas price-driven spike during the first seven months of the Great Recession.

The close-up of the last several years shows that the inflationary pulse began with the “Liberation Day” tariffs of April 2025, but was subsiding a little earlier this year, until the Iran war sparked a second round of more widespread price increases beginning in March:

In other words, the inflationary expansion continues.

But let me put this in some wider context as well, because it occurred to me that the T—-p Administration’s policies, with one major exception, are very similar to LBJ’s “guns & butter” fiscal policies during the Vietnam War.

Wars are expensive, and anytime a government wages one, generally it must either raise taxes (guns) or else cut other budget items, like goodies for the populace (butter). Hence, typically the choice is “guns *or* butter.” But if a government chooses to fund a war via the national credit card, and maintain its domestic priorities as well, that is the “guns and butter” approach. And both LBJ and T—-p have chosen the latter. In the case of T—-p, this also includes the Big Bad Budget Bust-out Bill’s upper income tax cuts, and also the stagflationary tariff impositions. Another huge difference is that LBJ’s “butter” was aimed at the poor and the working classes via the “Great Society” programs, while T—-p has directed a firehose of benefits to the ultra-wealthy and his cronies while (literally) taking the food out of the mouths of the food-insecure.

So now let’s look at what happened to interest rates on the 10 year Treasury (blue, left scale) vs. YoY consumer inflation (red) and Federal government expenditures (orange, normed to 100 as of January 1, 1964, right scale) during LBJ’s Presidency and beyond:

By the end of LBJ’s Presidency, Federal outlays had grown by 45%. By the end of the 2nd Quarter of his second year in office, they had grown by 4.2%. In early 1964, just after LBJ assumed the Presidency, the long-dated Treasury interest rate was just over 4%. By the end of his Presidency in January 1969, it has climbed as high as just over 6% in May 1968. In January 1964, consumer prices were rising at 1.6% YoY. By January 1969, inflation was 4.7%.

Now here is the same data for the last four years, plus the yield on the 30 year Treasury (which wasn’t issued until the mid-1970s):

So far in T—-p’s 2nd Administration, Federal outlays are up 6.2% (and that’s just 1 Quarter into the Iran war). Long-dated treasurys via the 30 year bond have risen from as low as 4% in late 2024 to over 5.3% earlier this month, and the 10 year has risen from 3.7% to 4.7%. And inflation, which was 2.4% YoY at the beginning of 2025, is currently at 3.4% after having risen as high as 4.2% several months ago.

There is no indication that T—-p has any consciousness of, let alone desire to change, any of the dynamics in “Guns & Butter II.” Thus there is every reason to expect a similar inflationary and interest rate record, with the exception that the ramifications of the closure of the Strait of Hormuz, or some other blunder, may unlike LBJ’s term, result in a stagflationary recession.

Some day the positive trend in unemployment claims will end —- but not this week

 

 - by New Deal democrat

As per usual on Thursdays, let’s take a look at the very good short leading indicator of jobless claims.

The bullet point take is that they continue to be among the most positive indicators of all at the moment. Last week only 206,000 people filed initial claims, down -6,000 from the week before. The four week moving average increased 4,250 to 204,000. And with the typical one week lag, continuing claims rose 18,000 to 1.799 million:

All of these continue at historically very low levels.

On the YoY% basis more important for forecasting, initial claims were down -11.6%, the four week moving average down -9.5%, and continuing claims down -8.1%:

This continues to be very positive for the economy.

Finally, let’s take our first look at what this likely means for the unemployment rate beginning in September:

Note this week instead of the usual representation of the unemployment rate, which is rounded to the first decimal, I used the actual numbers that make up the rate, showing how it has declined fairly consistently since the end of last year. The input from jobless claims suggests that there is still room for the unemployment rate to decline further, to 4.0% or even lower, and very little chance of any significant increase.

The mini-recession of 2025 vs. the AI wealth effect inflationary expansion of 2026

 

 - by New Deal democrat

No significant economic news today, so let’s take the proverbial “35,000 foot” look at the US economy in the past two years.

One of the things I have gone back and forth on over that time is whether there was a “mini-recession” late last year. As of the lastest revised data, I believe there was, from a peak in July through the end of the government shutdown in November.

Here’s a look at four important data series the NBER uses to date recessions: employment (blue), industrial production (red), real total sales (gold), and real income less government transfers payments (purple) for the past two years:

Two of the series, production and sales, hit interim peaks in July. The other two, employment and income, made peaks in September only slightly higher than their interim peaks in July. [Note, by the way, that I’ve had to amplify the volatility in employment *2 simply so that it doesn’t appear as a squiggle]. The average decline in the four series through the end of November was about -0.5%.

I haven’t included real GDP in the graph, partly because the NBER doesn’t particularly give it importance, and partly because real GDP can and has in the past - notably in 2001 - risen between the beginning and the end of recessions.

Last summer and autumn were only a “mini-recession” in part because the downturn only lasted 4 months, and partly because the -0.5% average decline was not sharp enough to qualify. By contrast, here are the same metrics for the shallow 2001 recession:

From peak to trough, in 2001 all four metrics declined at least -1.0%, and three of them by at least -1.5%.

Aside from not being deep or long enough, fundamentally why didn’t the mini-recession of 2025 manifest as a full-blown consumer-led downturn, despite real income declining more than -1.0% through April of this year? In addition to real total sales and industrial production trending higher by over 1% so far this year, the below graph tells the tale:

If real income has been down over -1%, and real aggregate payrolls only up 0.7%, stock market wealth has increased almost 25% since July of last year. 

This is the “K-shaped” economy. In addition to the inflationary tax cuts in last autumn’s Big Bad Bust-out Budget Bill, this 25% increase in stock market wealth has been driving a splurge in spending, the austerity being visited on those without stock market holdings be damned.

In conclusion, an important caution: these are coincident indicators; i.e., this is a nowcast, and should not be projected forward. Aside from a further geopolitical shock, per my commentary earlier this week, I would be looking for a downturn in corporate profits, and a downturn in real sales per capita, plus a continued stall in real aggregate payrolls, before I would change my current short term forecast. In other words, the above describes an inflationary expansion.

The positive trend in manufacturing production continues, but are there signs of flagging AI-related growth?

 

 - by New Deal democrat

If housing permits and starts are in the forefront of long leading indicators, then industrial production and its components are among the most important coincident indicators, even if they are not as important as they were back when the US was the world’s industrial powerhouse.

And if earlier this morning we saw housing continue its neutral trend, with industrial production we saw the goods-producing sector of the economy continue its upward one. To wit: headline production (blue) increased 0.2% in July to a new post-pandemic high, joined by manufacturing production (red) which increased 0.1%. Meanwhile, electric and gas utility production (gold), most closely aligned with AI data center construction, increased 0.7%. The below shows all three normed to 100 as of just before the pandemic:

You can see just how much utility construction has outpaced the manufacturing sector as well as the headline number in the past few years.

On a YoY basis, headline production was up 1.1%, its manufacturing component up 1.3%, and utilities up 0.7%:

There are two important takeaways from this month’s data: (1) manufacturing continues to improve at trend. There is no sign of it slowing down, but (2) the utility component most closely aligned with the construction of AI data centers shows significant signs of deceleration this year. The second may be critically important, since it is the driver of AI stock price gains and further downstream the spending driven by the wealth effect based on those gains.

The neutral trend in the most reliable long leading indicators in housing continues

 

 - by New Deal democrat

Let me start out this post with my updated overall conception of the long leading indicators. To begin with, most of them are financial — generally speaking, “the cost of money.” That applies to bond interest rates, the yield curve, real money supply, and bank lending. Recently, I’ve also indicated that fiscal policy should be added, as in, is there a major stimulus or austerity at work? But it is increasingly apparent that a recession does not occur until after the “real world,” non-financial long leading indicators also participate: corporate profits, real retail sales per capita, and - drum roll, please - housing permits and starts. 

Because although permits and starts are very much downstream of mortgage interest rates, they represent activity in the sector that constitutes the biggest consumer purchase of all, and through construction, landscaping, and furnishing, typically take around 2 years to fully filter through into the broader economy.

So let’s look at the numbers. To begin with, I no longer measure against the big 2022 interest rates hikes, because those have fully worked through the system. Thus almost all the graphs below are limited to the last three years. In the last several months I have written at length about how the entire housing market had reached an equilibrium, where almost all of the metrics were more or less flat.

This morning’s data on housing permits, starts, and units under construction for July continued that trend. Housing permits (blue) issued rose 69,000 to 1.443 million annualized, while the much more volatile number of starts (gold) declined -176,000 to 1.239 million annualized. Single family permits (red, right scale), which are the least volatile metric conveying the most signal, rose 22,000 to 894,000 annualized. The below graph shows each of them in comparison with their high water marks of the last several years, January and February of 2024:

Since that time, permits are off -8.1%, single family permits off -13.7%, and the three month average of starts off -17.8%. But perhaps more importantly, the stabilization of permits and starts slightly lower than their 2023-24 levels in the past 12 months is apparent.

In that vein, for me to consider housing recessionary, I would expect to see all three off at least -10% from recent highs, but also as the below historical graph shows, down -10% or more YoY:

Note that single family permits has turned positive YoY no later than 5 months after the end of any recession in the past 50+ years. 

But as the below graph of the last three years shows, not only are these metrics no longer down more than -10% YoY, but two of the three are positive, as permits are up +3.1% YoY, single family permits up to+1/1%, and only starts down -13.8% (-6.4% for the three month moving average):

This is no longer recessionary.

Last year I was calling housing units under construction the “last shoe to drop;” and after a plateau in 2022-23, it had been dropping like a rock, as shown in the graph below. But then it too started to stabilize, as this series has been virtually unchanged for the past seven months:

And the below historical graph is what really grabbed my attention, because in the past it has only flattened out, and started to improve on a YoY basis, only at the end of recessions and beginnings of expansions. And that is exactly what the YoY comparison shows now:

Units under construction are still down -6.0% YoY, but this is the best YoY comparison in 24 months. This is most consistent with a rebound after a recession.

To sum up, residential construction metrics in July continued the sideways trend, of a subpar housing equilibrium — but an equilibrium that nevertheless means this long leading indicators for the economy is no longer recessionary, but neutral.

Of inflation and corporate bond spreads

 

 - by New Deal democrat

Over the weekend, in response to my “Weekly Indicators” post, a commenter wanted to know why I was concerned about inflation. After all, hadn’t core CPI just tied its post pandemic low?

And it is true: core inflation (blue), at 2.5% YoY, is equal to its post-pandemic low. Further, CPI less energy (red), a measure I used to cite monthly before COVID stimulus-induced house price inflation dwarfed everything else, did make a new post-pandemic low YoY through July:

But in reply, I noted that not only was headline inflation still elevated, but pipeline price pressures were manifest in both the ISM monthly reports and the various Fed regional reports, one of which - the New York Fed’s Empire State manufacturing survey - was updated for this month this morning, and it showed continued widespread increases in both prices paid (blue) and received (orange). In the graph below, I also show the latest Philadelphia Fed readings (light blue and light orange) through last month:

Interestingly, although prices paid if anything have become more widespread in the last few months, relatively speaking producers are having a difficult time passing them all on. This is going to squeeze profit margins, and that tends to lead to cutbacks.

And gas prices through the first half of August have increased compared to July:

And of course the Strait of Hormuz is still closed, Wall Street futures traders notwithstanding. 

So yes I continue to believe that inflationary pressures have been building.

Which brings me to a second point that I made in my piece over the weekend: namely, that the increase in yields on bonds at longer maturities is a negative sign. That point was reinforced with another piece of information that was posted by Apollo Research via Carl Quintanilla, pointing out that yields on speculative corporate credits have - at least somewhat - blown out.

To wit: below is a graph of the last three years of bond yields for CCC grade speculative debt (blue), BBB debt (gold), BAA debt (red), and 30 year Treasurys (black):

Note that I’ve subtracted -5% to CCC yields better to show the comparison in trends. There’s no doubt that there has been some spreading.

Unfortunately, B of A only allows FRED to post the last three years of data. So here is a graph of CCC vs. BB corporate debt going back 30 years:

Whenever bond traders get worried, the speculative high yield CCC debt blows out first and worst. In comparison, the current relative increase in CCC debt is not that significant - at least not yet. Also, when the economy weakens, banks become more wary about extending loans for speculative debt, as shown in the relevant metric of the Senior Loan Officers Survey, which was just updated two weeks ago:

Through Q2 of this year, there was no such wariness yet.

As I’ve written a number of times recently, the current situation is best described as an inflationary expansion. Before it ends, among other things I would expect banks to tighten credit, high yield CCC debt to blow out considerably more against more creditworthy B-grade corporate debt, and I would expect even better rated corporate debt to increase in yield as well.