Joseph G. Carson

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The Institute of Supply Management (ISM) composite index for manufacturing fell 7.6 points to 41.5 in April, the lowest level since the Great Financial Recession. As bad as the headline numbers appear at first glance the "internals" of the monthly survey are
 even more alarming. In April, the new orders index fell 15 points to 27.1, while the production index fell 20 points to 27.5. In the history of the ISM index, which goes back to 1948, there are only two readings in May 1980 (government-imposed credit controls)
 and December 2008 (fallout from Great Financial Recession) that recorded combined lower readings on new orders and production indexes.

The ISM manufacturing index was initially created in the early 1980s by Mr. Ted Torda, a colleague of mine at that time at the Office of the Chief Economist at the Department of Commerce. The initial launch of the ISM manufacturing index awarded new orders
 and production components the largest weights (30% each). Using the original weights the April 2020 composite index would have dropped to 36.6. (Note: nowadays these two subcomponents along with employment, supplier deliveries, and inventories are given equal
 weights of 20%). The initial research showed that the up and down movements in new orders and production offered the most accurate assessment of the current state of manufacturing. The April readings on new orders and production indicate that the current state
 of the manufacturing sector is far worse than what is implied in the overall composite index. And as bad as business conditions are today, firms are saying conditions are not likely to improve in a major way anytime soon. One of the most accurate forward-looking
 indicators of the ISM survey is to compare the levels of new orders index to the overall composite index. The rule is that when new orders run below the composite index the near term direction of manufacturing is lower/bleaker, whereas when the new order index
 runs above the composite index the near-term outlook is higher/brighter. In April, the new orders index had a minus -14.4 reading relative to the overall composite. That's the most negative reading in the 70-year plus history of the ISM survey. That record
 low reading is a way companies saying "current conditions are bad and we have no visibility when conditions will improve."
 
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The Institute of Supply Management (ISM) composite index for manufacturing fell 7.6 points to 41.5 in April, the lowest level since the Great Financial Recession. As bad as the headline numbers appear at first glance the "internals" [...]

ISM April's New Order & Production Crash

Peter D'Antonio

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Given the sudden dive in economic activity due to the COVID-19 pandemic, the April 2020 employment report will be both historic and eye-popping. The unemployment rate is likely to rise to its highest level since the Great Depression, with consensus estimates in the 16 to 17 percent range. The single month rise of about 12 percentage points would be multiples of the biggest increases of the past 70 years. Meanwhile, the April drop in payrolls could be in the tens of millions, dwarfing any previous monthly decline. These figures no doubt will be the focus of the headlines after the employment report. However, there will be other historic changes in the employment report that will bear watching for clues about the impact of the work stoppages on the labor market. Some economic data – namely, the average duration of unemployment and average hourly earnings – will move in counterintuitive directions.

The ADP employment report, scheduled for release on May 6, is the next place to look for information about the loss of jobs, following the unprecedented surge in initial claims. This report is designed to give an early reading on the official payroll report. The size of the decline in these data and the establishment survey depends on whether employers kept workers on the books in April.

Importantly, there is information in the ADP report that is not included in payrolls – specifically, a breakdown of employment changes based on size of employer. Since there is widespread concern that the COVID-19 restrictions have predominantly impacted small businesses, at least initially, these data may give valuable insights into the extent of that impact.

When the payroll report itself is released, we will see that unemployment soared and payrolls collapsed. However, the likely change in the average duration of unemployment and average hourly earnings may cause some head scratching.

The average duration of unemployment is a weighted average of the length of unemployment stretches. Typically, we associate short average durations with strong labor markets and long average durations with weak labor markets. This characterization is reasonable, because unemployed workers may find it more difficult to find work and remain unemployed for longer during downturns and vice versa.

Counterintuitively, in the current environment with millions of people suddenly losing their jobs, the average duration of unemployment is likely to drop precipitously. A jump in the unemployment rate to the 16 to 17 percent range would be consistent with a decline in the average duration from 17.1 months in March to roughly 6 months in April. That would be the lowest reading and the sharpest change in the gauge's history dating back to 1948. The steep decline would reflect the fact that there are so many short-term unemployed workers, out of work for a month or less, which will drive down the average.

Gains in average hourly earnings typically rise in tight labor markets and decline in soft labor markets. That is why a sudden rise in earnings, coinciding with a jump in the unemployment rate, will come as a surprise. However, a pickup in earnings gains would merely reflect a change in weighting away from low wage workers. By most accounts, retail and low skilled workers bore the brunt of the layoffs and cutbacks in hours, while higher skilled workers and those who could work from home remained employed. Without these low wage worker hours in the calculations, the rise in average hourly earnings could jump to 6 percent or more, a gain not seen since the early 1980s.

There is an important caveat to April payroll report readings, because the sample size for the survey likely will be extremely small for a first pass. Many firms probably were not available to fill out the survey due to closures or remote work. So, there could be unusually large revisions to the April data in coming months.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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Given the sudden dive in economic activity due to the COVID-19 pandemic, the April 2020 employment report will be both historic and eye-popping. The unemployment rate is likely to rise to its highest level since the Great Depression, [...]

An Employment Report Like No Other

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The great divide between finance and the economy rolls on. In the past 6 weeks, jobless claims have increased by 30 million, while the S&P 500 index has increased by more than 30%.

The last decade saw the greatest divide ever between finance and the economy. At the end of 2019, household holdings of equities stood 2 times the level of disposable income, an all-time high.

That divergence between finance (stock market) and the economy was fueled by easy money. To be sure, policymakers kept official rates near zero for roughly half of the 130-month economic expansion. Also, except for a brief 6-month period in early 2019, policymakers kept official rates below the core rate of inflation. Never before in any business cycle has official rates remained below the inflation rate for almost an entire growth cycle.

In 2020, the policy of easy money policy has gone to new heights. On March 23, the Federal Reserve announced plans to make unlimited purchases of financial assets to support the financial markets while also indicating they planned to utilize emergency lending powers.

Artificially evaluating finance over the economy does not guarantee a recovery, while it can also lead to financial instability at some point as asset prices become unhinged to underlying corporate profitability.

Cheap money can create the illusion of recovery, but a policy that results in more debt and inflated asset prices is not a bridge to recovery; it's another bubble.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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The great divide between finance and the economy rolls on. In the past 6 weeks, jobless claims have increased by 30 million, while the S&P 500 index has increased by more than 30%. The last decade saw the greatest divide ever between [...]

30 For 30: 30 Million Jobless Claims vs. 30% Gain in Equity Prices

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Even though the media has put a spotlight on the rising number of confirmed COVID-19 cases in the United States, that is the wrong statistic to look at when trying to assess the risk of spread. Rather than the number of confirmed cases, which stands at 852,000 nationwide and 252,000 in the epicenter of New York State, the statistic that matters is the number of active cases, which is the number of people who currently have COVID-19 and are contagious. This is the information needed when considering relaxing the social restrictions. Although the United States does not have good data on active cases, we can make judgments based on trends from outside the country, particularly Germany. The resulting estimate of US active cases is much lower than confirmed cases. Importantly, the trajectory flattened out in mid-April, with New York starting to decline.

The focus on confirmed cases is misleading for two reasons. First, the confirmed cases statistic, a tally of all COVID-19 cases since the beginning, is a cumulative number that must rise by definition. Solely focusing on this statistic trains the eye on an endless stream of bad news as we reach new record highs, regardless of whether the situation is getting better or not. Second, the vast majority of people do recover. People generally become symptom free within 14 days of testing positive. Since this disease has been in the United States for two months now, recoveries are well underway. Yet we continue to count them in the confirmed cases tally and keep pointing to that ever-rising statistic as a benchmark for how poorly we are doing in the fight against the disease.


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In contrast, the number of active cases gives an indication of the current pervasiveness of the disease. Active cases can be calculated by subtracting recoveries and deaths from confirmed cases. Unlike recoveries, deaths, and confirmed cases, which are all cumulative, active cases can rise or fall. The trajectory of active cases is key to recognizing any progress containing the disease and ultimately reducing its social and economic impact.

Unfortunately, we do not have good estimates of active cases. Like most countries, the United States has done a poor job of collecting data that would determine the number of active cases. Specifically, the government is not following up with confirmed cases in a timely manner to produce realistic estimates of recoveries. The official total of US recoveries is just 77,000, which is 9 percent of confirmed cases and obviously too low. Most other countries' recovery statistics also lag far behind their tallies of confirmed cases. The severe undercount of recoveries implies that the US is grossly overestimating the trajectory of active cases.

Using trends from Germany, where authorities have been at the forefront of testing and have realistic recoveries data, we can make reasonable estimates of the prevalence of the disease in the United States. The German data show that about 90 percent of people who test positive for COVID-19 recover within two weeks. Once the virus is contracted, there doesn't seem to be any reason US recoveries should take longer or shorter than German recoveries. It is therefore my belief that the United States can apply the German recovery rate – 90 percent of confirmed cases recover two weeks after testing positive – to make a rough estimate of the number of active cases in the United States.

Based on these calculations, the number of active US COVID-19 cases is much lower than the number of confirmed cases. More importantly, the trajectory has improved notably. The number of active cases in the United States is 421,000 and has held at that level since April 15. In New York, the story is even more encouraging. The number of active cases peaked at 127,000 on April 13 and actually began a steady decline. By April 21, the number of active cases in New York had fallen to 118,000. In other words, the number of people recovering is rising faster than the number of new cases.

The number of confirmed cases, which continues to rise steadily each day, will keep doing so by definition. Moreover, the number of people who have contracted COVID-19 is probably much larger than the official number of confirmed cases, as the mildest cases and asymptomatic cases are generally not being tested. This, in turn, means that active cases are likely higher than these estimates. However, the mild and asymptomatic cases recover as well, probably sooner on average than other cases. Even at higher levels, there is no reason to doubt the flattening and decline in the trajectory of active cases. This is being confirmed in New York hospitals, which are seeing more discharges than admittances.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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Even though the media has put a spotlight on the rising number of confirmed COVID-19 cases in the United States, that is the wrong statistic to look at when trying to assess the risk of spread. Rather than the number of confirmed [...]

Focus Should be on COVID-19 Active Cases, Not Confirmed Cases

Charles Steindel

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The Philadelphia Federal Reserve Bank has issued estimates of state coincident indexes for March, and the results are truly ugly.
<a href="https://www.philadelphiafed.org/-/media/research-and-data/regional-economy/indexes/coincident/2020/coincidentindexes0320.pdf">The Bank's release</a> shows a map illustrating three-month changes, and it is largely a frightening field of red. Three-month changes seem a bit academic at this point. Looking at the changes from February it's a bit surprising to see 14 states coming in with upticks—arguably a reflection of the plunge only so far lasting one month, so it's possible those small gains will not be there when April information comes in. Alaska and Hawaii had the largest increases.

24 states had one-month declines larger than 1 percent, with West Virginia down an astonishing 5.2 percent, Kentucky off 4.5 percent, and Nevada dropping 4.4 percent. In the very largest states, California fell more than 2 percent—surely a reflection of its early lockdown—Florida was off 1.6 percent—the delay locking down there didn't prevent the shrinkage of travel (clearly evident in Nevada's collapse) dragging the state down, notwithstanding the large news coverage of spring break—New York was down 1.5 percent, and even Texas fell a marked .9 percent; larger than the national figure of .5 percent, likely heavily affected by the fall-off in energy extraction and refining.

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The Philadelphia Federal Reserve Bank has issued estimates of state coincident indexes for March, and the results are truly ugly. The Bank's release shows a map illustrating three-month changes, and it is largely a frightening field [...]

State Coincident Indexes in March

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The strong rebound in equity prices since mid-March suggests investors are banking on a fast rebound in the economy once government eases the restrictions on work-life, travel and social and recreational gatherings. Reopening regions or sectors of the economy
 will undoubtedly produce a statistically powerful rebound; triggering a race among analysts to revise up growth estimates as fast as they raced to reduce them.

But "boomerang" statistics on jobs and GDP does not mean a return to the "best" economy for the simple it was not the best before. Here's why.



Corporate Profits: In 2019, operating profits for US companies totaled $2.075 trillion, essentially unchanged from the prior year. That flat performance represents the fifth consecutive year of no growth in corporate profits. It would be flat out wrong to characterize
 the economy's recent performance as the "best" when corporate profitability has stalled for 5 consecutive years.

Even if the current recession proves to be short in time, it still will be historic in terms of the scale of decline in operating profits.

The peak to trough decline in operating profits during the Great Financial Recession was 40%. But that drop in operating profits occurred against a 3% peak to trough decline in Nominal GDP.

Currently, consensus economic forecasts point to a decline in Nominal GDP two or three times greater than what took place in 2008/09. Accordingly, investors should brace for a 60% to 70% decline in operating profits, and a long road back to pre-recession earning levels.



Corporate Debt: At the end of 2019, nonfinancial corporations had outstanding debt and loans of $10.1 trillion, nearly double what these firms on their balance sheet at the start of the last decade. A relatively large part of the debt binge was used for financial
 engineering (i.e. stock buybacks) instead of engineering for innovation and making things.

In recent weeks, commercial and industrial loans have increased nearly $500 billion as firms drew down credit lines to increase cash and liquidity levels. Also, Congress gave the federal government and the Federal Reserve the authority to initiate a new lending
 program for small and mid-sized companies. So the level of corporate indebtedness will continue to increase further even as the economy nosedives.

The road from recession to recovery is based on "reliquification, or the process of freeing up of cash flow by refinancing existing debt obligations for lower interest payments, longer terms or by paying down debt.

Extending more debt to companies is the exact opposite of the practices that were employed in the past to help the economy escape recession. Enabling companies to stay afloat by adding to existing debt levels might stop the economic bleeding in the short run, but it
 does not make the economy stronger or better. The payback will be weak growth as firms struggle with record debt levels.



Finance vs. Economy: The last decade saw the greatest divide ever between finance and the economy. At the end of 2019, household holdings of equities stood 2 times the level of disposable personal income, an all-time high. Also, the market value of domestic
 companies to Nominal GDP stood at a record 1.9 times, exceeding the prior record high of 2000.

The divergence between the stock market and the real economy was fueled by easy money. To be sure, policymakers kept official rates near zero for roughly half of the record 130-month economic expansion.

Also, the cycle high of 2.37% in the federal funds rate represented the lowest nominal peak rate in the post-war period, and only for a short 6-month span in early 2019, did the fed funds exceed the core rate of consumer price inflation.
Never
 before in any business cycle has official rates remained below the inflation rate for almost the entire growth cycle.

In the end, monetary policy stimulated finance over the economy and in the process created an equity market that was "too big to fail"; and its fall deepens the recession and slows the recovery.

The US economy has the potential to be the "best". But to be the "best" it needs to clean up corporate balance sheets and follow best policies and best practices.

Best policies means the capital markets fairly and freely price and allocate credit and capital. Best practices means firms focus on innovation and making things.

 "Are we there yet?" Unfortunately, from a public policy and business practice perspective the US is moving in the wrong direction.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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The strong rebound in equity prices since mid-March suggests investors are banking on a fast rebound in the economy once government eases the restrictions on work-life, travel and social and recreational gatherings. Reopening regions [...]

The "Best" Economy: Not Before, Nor After Coronavirus

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The March state data provide first firm data on the regional impact of the pandemic. 31 states saw statistically significant drops in their job counts; Tennessee—a state that was quite late to impost shut-downs—was the only state to report an increase (not statistically significant). California lost 99,500 jobs; the counts in both Louisiana and Rhode Island both fell 1.1 percent. Louisiana and Rhode Island. Two large states that were slow to close—Florida and Texas—still saw .4 percent losses. Only a dozen states now report statistically significant job growth over the last 12 months, with Utah up 2.6 percent. But the negatives have started to accumulate, with Vermont down 2.4 percent and West Virginia dropping 1.7 percent (both these states had been soft to weak prior to the pandemic).State labor markets were generally sound in February, prior to the onset of the pandemic.

Household survey results were also dismal. Nevada—a state utterly dependent on travel and tourism—saw its unemployment rate soar 2.7 percentage points, from 3.6 percent to 6.3 percent. Louisiana, not doing well earlier, reports a 6.9 percent jobless rate. West Virginia, Pennsylvania, and the District of Columbia also had unemployment rates of 6.0 percent or higher (Alaska, long the state with the highest unemployment rate, reported a drop from 5.8 to 5.6 percent). In the four largest states (California, Texas, New York, and Florida) noticeable drops in the labor force—at least 1 percent in each--dampened the rise in reported unemployment. Six states, though—scattered across the nation, from New Hampshire to Hawaii—continued to report unemployment rates under 3 percent. Astonishingly, New Jersey—one of the very hardest his states by the virus—reported an unchanged 3.8 percent rate, with increases in the labor force and resident employment (the Garden State’s job count, though, fell 31,800). A good sign of the disarray created by the virus is the omission of household survey data for Puerto Rico—it was just not possible to conduct anything like a normal survey on the island.

As many noted, the March survey period for the labor market reports came before the full force of the pandemic hit; the incredible rise in new claims for unemployment insurance started later in the month. Still, it’s obvious that the national impact is being felt coast to coast.

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The March state data provide first firm data on the regional impact of the pandemic. 31 states saw statistically significant drops in their job counts; Tennessee—a state that was quite late to impost shut-downs—was the only state to [...]

State Labor Markets in March

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As difficult it was to decide to shut down large segments of the economy in order to contain coronavirus it will be even trickier to decide when to end the lockdown. News that the coronavirus curve (i.e., the number of cases) may be flattening will only intensify
 the pressure on government leaders to relax restrictions on work-life and travel, as well as social and recreational gatherings.

There is a risk in removing government restrictions too early in a war against a virus. History shows it is essential that "the chain of transmission" of the virus is severed as a second wave could prove to be even more damaging.

In 1980, government-imposed credit restrictions to kill the "inflation" virus. At that time, "inflation" was labeled as public enemy number one much like coronavirus is viewed today.

The decision to impose credit controls to attack the "inflation" virus literally "scared people away from the stores" (The Wall Street Journal, May 5, 1980) triggering the sharpest one-quarter decline in consumer spending in the post-war period.

The National Bureau of Economic Research (NBER), the official arbiter of dating economic cycles peaks and trough, viewed the sudden drop in business activity to be so severe it announced that the economy was in recession even before the official GDP data showed
 an actual contraction. That surprising announcement by NBER compelled the federal government and the Federal Reserve to abruptly end the credit-control program, only 90 days after it was first implemented.

Investors will be pleased to learn the removal of government restrictions on credit sparked a quick and powerful rebound in the economy. Real GDP posted back-to-back quarterly gains of nearly 8% annualized in Q4 1980 and Q1 1981. The entire decline in consumer spending
 and output loss of the short 6-month recession was recaptured.

However, investors should be alarmed to learn the chain of transmission of the "inflation" virus was not severed. Instead it was alive and well, ready to resurface once the economy rebounded.

The second wave of the "inflation" virus proved to be more damaging as it forced the Federal Reserve to implement broader and more stringent monetary constraints. A deeper and more protracted recession followed, lasting 18 months from the middle of 1981 to the
 end of 1982.

Looking back on the 1980 experience economic and policy experts voiced concern that not enough was done early on to break the chain of transmission for the "inflation" virus.

Federal Reserve Board Vice Chairman Frederick Schultz in testimony before Congress in late 1980 stated, "Now, with the benefit of 20/20 hindsight… I think there is a considerable risk that the underlying problems of the economy will be found to be even more intense
 once the period of credit controls has been ended…the quick-fix or the band-aid policy always looks attractive, but that is a cruel deception". Mr. Schultz was right.

2020 recession like that of the 1980 recession is similar in that both are government-made, linked to a "contagious" virus, and involve a sudden stop in the economy. The difference is that the 1980 recession involved an economic virus versus today's medical one.

As such, investors must realize the timing, scale and sustainability of any business rebound are not forecastable. Recovery depends on the coronavirus curve that has no economic properties and the success of medical science.

At this point, it would be best for the government officials to follow science and let the data determine the timing of the "on" switch for the economy. The last thing anyone wants is to have a medical expert testify before Congress in 6 months (like that of
 Mr. Schultz in 1980) and say "wish we'd done something more in the spring" to break the transmission chain.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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As difficult it was to decide to shut down large segments of the economy in order to contain coronavirus it will be even trickier to decide when to end the lockdown. News that the coronavirus curve (i.e., the number of cases) may be [...]

Lessons from the 1980 "Inflation" Virus: Transmission Chain Needs to Be Broken for Successful Outcome

Headline US PCE inflation elevated by sticky services prices

US and global equity prices have recently diverged

US leading global upturn in economic surprises

Blue Chip forecasters look for further significant monetary easing apart from Japan

Recent rise in global supply chain pressures could augur a pickup in global inflation pressures

Underperforming German economy generating increased policy uncertainty relative to Europe and the US

Resilient US economy is pushing up longer-term inflation expectations and interest rates

Positive US economic data surprises leading to upward adjustment of interest rate expectations

Recent aggressive policy easing in China has given a massive boost to equity prices

FOMC expects much more easing now than in June

US is clear world leader in business capital spending on artificial intelligence

Blue Chip forecasters expect US to lead aggressive policy rate cuts over coming year—apart from Japan

Ratio of job openings to the number unemployed in the US now below pre-pandemic level

U.S. layoffs not showing as much cooling in labor markets as unemployment rate

While goods prices have moderated, service price inflation remains elevated and sticky

Since Jan 2023, BCEI US outlook has improved, worsened for Japan and the euro area

Persistent negative US economic surprises leading to big rate-cut expectations

Germany is Euro area weakling

Flash PMIs show good start to Q3 in US; loss of momentum in the euro area

Chinese economy on downtrend could threaten global economy

Working age population labor force participation near all-time high as retirements increase

Blue Chip forecasters look for widespread policy rate cuts just ahead

Flash June PMIs point to a widespread slowdown apart from the US

Announcement of snap French election is causing concern across Europe

The UK economy’s post-pandemic under-performance relative to its pre-pandemic trend

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The Federal Reserve Bank of Philadelphia’s state coincident indexes were again soft in October.. In the one-month changes, South Dakota led with a .67 percent gain, and Connecticut, Ohio, and Delaware had increases above .5 percent. However, the indexes for 13 states declined, with South Carolina and Michigan both down .4 percent (Michigan saw some pronounced retrenchment in autos, and South Carolina would have been hit by the Boeing strike). Over the 3 months ending in September, 12 states were down, with South Carolina (down 1.4 percent) and Massachusetts (off 1.1 percent) once again at the bottom. Connecticut was yet again at the top, with a 1.7 percent increase, with Over the last 12 months, 3 states were down, and 10 saw increases of less than 1 percent. South Carolina’s index was off by 1.2 percent. Arizona had a 4.9 percent increase, and Connecticut was up 4.7 percent, with 7 others up more than 3 percent.

The independently estimated national estimates of growth over the last 3 months (.55 percent) and 12 months (2.55 percent) appear to be roughly in line with the state numbers.

State Coincident Indexes in October 2024

State labor markets were little-changed in October. The Boeing strike, and Hurricane Milton, triggered statistically significant declines in payrolls in Washington and Florida. There were no other statistically significant changes, not even in North Carolina (which did have a insignificant drop). Nonetheless, the sum of payroll changes across the states was -76,400, a clear amount lower than the independent national change of 12,000.

Three states had statistically significant declines in their unemployment rates in October, and one  showed an increase.  None of the changes were larger than .2 percentage point.  The highest unemployment rates were in DC (5.7%),  Nevada (5.7%), California (5.4%), and Illinois (5.3%). No other state had rates as much as a point higher than the national 4.1%. Alabama, Hawaii, Maine, Mississippi, Nebraska, New Hampshire, North Dakota, South Dakota, Vermont, Virginia, and Wisconsin had rates of 3.0% or lower, with South Dakota at 1.9%.

Puerto Rico’s unemployment rate dropped to 5.4%--lower than both DC and Nevada, and matching California--while the island’s job count grew by 2,300.

State Labor Markets in October 2024

The new administration intends to pursue an unconventional fiscal strategy. A key aspect of the strategy involves reducing or abolishing non-defense government agencies in order to create fiscal space to make the current tax law permanent, lower taxes even more, and generate extra revenue through an extensive and significant tariff program.

The success of the fiscal policy of the new administration will depend on the reaction of the bond market, which has historically influenced policy changes. Three decades ago, Bill Clinton pledged a stimulus package if he won the election, but upon taking office, he had to shift towards a "financial market strategy" instead. Stimulus spending was abandoned in favor of a deficit reduction plan to prevent long-term interest rates from increasing. Given the imbalance in the federal budget is much larger today, it is crucial for policy decisions to take into account the bond market's reaction, raising the question whether policymakers will heed the advice as they did in 1993.

The odds are in favor of the opposite happening, as the new administration is not inclined to give in to the pressures of the bond market. If bond yields jump sharply, the administration might urge the Fed to intervene, potentially worsening the situation.

**The Federal Budget**

In the fiscal year 2024, total federal spending reached $6.75 trillion, resulting in a budget deficit of $1.83 trillion. Currently, defense budget and social programs are deemed off-limits, as are interest payments. This shifts the attention towards cutting expenses in non-defense discretionary spending.

During the fiscal year 2024, non-defense discretionary spending amounted to approximately $950 billion. Although non-defense spending had stayed stable in nominal values between 2010 and 2019, it surged in 2020 as a result of economic recovery initiatives through additional legislation. Nevertheless, there is a pattern of downward trend in non-defense expenditure even prior to the upcoming Congressional term, with forecasts indicating a decline to 2.5% of GDP over the next ten years as per the Congressional Budget Office. The smallest proportion of such outlays in the past five decades was 3.1%.

Although additional spending cuts may still occur, the meager budget share allocated to these programs indicates that the extent of budget savings is significantly smaller than advertised. Below are some more reasons why significantly cutting non-defense discretionary spending will pose political challenges.

With a budget of $238 billion, the Department of Education provides support to almost 100,000 public schools through its programs.

With a budget of $106 billion, the Department of Commerce supports research and development in emerging technologies such as artificial intelligence.

With a budget of $460 billion, the Department of Agriculture funds many projects in rural communities, including housing, community facilities, and utilities.

With a budget of $275 billion, the Department of Transportation makes billions of dollars in grants to improve and upgrade all types transportation systems.

Non-defense federal spending plays a critical role in the economy by offering assistance to businesses of different scales and types, along with state and local governments and individuals. This does not imply approval of the Federal budget or its spending preferences, but rather recognizing essential elements concerning federal spending and its economic influence.

Furthermore, handling the distributional effects of significantly reducing non=-defense spending will pose significant controversy and implementation challenges. For example, states in the northeast pay more in federal taxes than they receive in federal spending, while various states in the south, as well as a few in the mid-west and southwest, receive more assistance than they contribute in taxes. This raises the question of whether politicians from states receiving the most aid will support legislation that significantly reduces the assistance provided to their constituents. Every state listed that gets more in federal assistance than they pay in taxes voted for the new administration.

Extending the 2017 tax cuts adds another layer of complexity to the new administrations fiscal plan. The Congressional Budget Office projects that prolonging these tax cuts could result in a $4.6 trillion increase in the deficit over the next ten years. To counterbalance this, Congress would need to enact spending cuts averaging more than $450 billion a year, affecting almost half of non-defense spending. Moreover, there are discussions about proposing further reductions in federal taxes.

Implementing a comprehensive and substantial tariff program could lead to increased revenue. However, the effectiveness of this strategy is uncertain, as it relies on the assumption that foreign trade partners will not retaliate. Additionally, foreign entities play a crucial role in aiding the US in meeting its federal borrowing needs, hence implementing a tariff strategy is like informing your creditor that you intend to cease transactions with them but expect them not to demand repayment of your loans.

The tariff plan could potentially create complications for both the economy and the bond market. Significant risks include the possibility of higher consumer inflation, which may raise the expenses of social programs (such as inflation indexation) and widen the budget deficit. Additionally, it could lead to higher interest rates, affecting policy rates accordingly.

The new administration has expressed interest in influencing the Federal Reserve's interest rate decisions and has even proposed replacing the Fed Chair before his term expires in 2026. Unlike other government agencies that report directly to the President, the Federal Reserve is an independent agency accountable to Congress. Altering the Fed's independence would require legislative action, potentially causing disruption in the financial markets. The odds of changing the status of the Fed is minimal, but that does not mean the new administration will not publicly expressing its views, which pose challenges for the Fed and confusion (volatility) in the financial markets.

The new administration faces a specific challenge when it comes to dealing with the bond market, particularly due to the fact that it is commencing with an excessively large budget deficit that is forecasted to grow over the next decade. The sheer size of the bond market renders it impervious to being swayed solely through rhetoric or public persuasion. Irrespective of the new administration's declarations or viewpoints, the bond market will express its position on fiscal policy. Three decades ago, the Clinton administration changed direction when the bond market rejected a stimulative fiscal plan. If the new administration's fiscal strategy indicates larger budget deficits and increased inflation, the bond market's rejection will be more significant than that of 1993.