Joseph G. Carson

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Recessions are far from being alike and their symptoms and causes differ over time. Despite its many shapes and sizes the historical regularity that an inverted Treasury yield curve has coincided with recession has raised concern now that yields on longer-dated Treasuries have fallen been below shorter-term yields for several months running.

The power of the term spread to predict or anticipate economic recessions needs to be respected, but there are several new domestic and global factors that are present today, suggesting that the signaling effect from changes in the Treasury yield curve directly to the economy's future performance might not be as robust as it was past periods.

First, this is the first economic cycle that involved a bond-buying program by the Federal Reserve. The quantitative bond-buying program produced a technical anchoring effect at the long-end of the bond market that was not present in prior cycles. While this program did not cause a yield curve inversion by itself it did result in a flatter yield curve than what otherwise would have been the case, and as a result, it would not take much force from other factors to trigger an inversion in the term spread of yields.

Second, given the increased globalization of the financial markets the appeal and demand of long-dated US Treasury securities is often based on the yields available in other major economies. Long bond yields in a number of major economies (such Germany, Japan and France) are negative and many others (including the UK, Spain and Australia) are below 1% and that has led to an increase in global demand for long-dated US Treasury securities since yields in the US are in some cases 100 to 200 basis points over the yields of comparable maturities in other economies. That increased global demand for US securities is a new technical factor and unrelated to the performance of the US economy.

Third, this is the first time the inversion of the Treasury curve occurred with nominal yields at the short and long end that were well below the growth in nominal income and GDP (or the economy's yield curve). Why is that important? There is a direct negative consequence to the economy's performance when the cost of borrowing exceeds the growth in nominal income. At that point, the cost of new borrowing starts to become too costly, leading to a slowdown or a decline in credit use, and a weaker economy.

Although it is often overlooked, all of the Treasury yield curve inversions that have preceded recessions have coincided with an inversion in the economy's yield curve, or when short and long-term nominal rates were above the growth in nominal income and GDP. The fact that the Treasury yield curve has inverted at relatively low nominal yields, suggests that the interest rate channel is not producing the restrictive influences on the economy as it did during prior inversions and instead is actually providing a cushion (or stimulus) to the economy. Policymakers should take note of this unusual occurrence and not rush to ease policy further, saving its interest rate powder for another time.

If the Treasury curve inversion is not producing a restrictive influence on the economy as it did in the past can the US still experience a recession? Yes, but it would come from different channels.

The biggest recession risk today centers around the trade dispute between the US and China. Trade disputes have the potential to be very disruptive and contractionary and can operate through a number of channels, such as trade volumes and production, currencies and prices and asset markets.

Of all of these channels, the biggest vulnerability for the US is the equity channel since the market value of equities relative to income and GDP is at record highs, providing consumers with vast sums of liquidity and wealth. If the imposition of new tariffs and the uncertainty over what may follow triggers a de-risking and rush to exit, sparking a sustained 25% to 30% correction in the equity market that by itself could trigger a recession as it would deal a substantial blow to consumer liquidity and wealth, and an abrupt and sharp decline in spending and confidence.

That is not a forecast or a prediction but merely an observation that all recessions have been caused by some form of a demand shock, and the inverted yield curve merely highlighted the vulnerability of the economy to a potential bad outcome.


Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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Recessions are far from being alike and their symptoms and causes differ over time. Despite its many shapes and sizes the historical regularity that an inverted Treasury yield curve has coincided with recession has raised concern now [...]

Recession and the Signal from the Treasury Yield Curve

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The Trump Administration, with support and consent from Congress, has cobbled together a lopsided federal budget, loaded with upfront stimulus, financed with huge borrowings, only to be reversed in future years with doubtful spending cuts and tax hikes. The uneven and deficit-financed budget creates a number of potential problems.

Although there is no exact tipping point the relatively high and rising levels of federal debt relative to GDP puts the US in a high-risk category, and countries with high debt levels are usually unable to respond aggressively to a downturn. Yet, the bigger long run issue is the "structural" imbalance between the new tax law and spending legislation as current projections show that the budget deficit will continue to widen even during periods of sustained economic growth.

The debt ceiling legislation just approved by Congress is a good example of how short-term political considerations are driving budgetary decisions. Needing to pass an extension of the debt ceiling politicians decided to attach legislation that would extend for another two years the 2017 spending agreement on defense and discretionary spending. The new agreement increases defense and domestic spending by $320 billion over the next two fiscal years—at a time when the budget deficit is already on a path to hit $1 trillion.

But for politicians running for re-election in 2020 the new spending agreement was a "good" deal as it averts a spending cliff—and a negative hit to growth and employment--- since spending authority for defense and several domestic agencies would have been re-set at much lower levels, cutting billions from a wide range of programs.

Politicians used a similar gimmick with the 2017 tax legislation. Faced with a Senate rule that any legislation cannot add to the federal deficit beyond 10 years politicians were forced to agree to a phase out deductions for business investment and to make the individual tax cuts temporary, agreeing to raise all of the individual tax rates back to pre-2017 levels and to reverse all of tax –reducing changes in credits and deductions starting in 2026.

Is it realistic to think that politicians will phase out valuable tax deductions for new investment? The business community will be up in arms in a few years, arguing how "unattractive" and costly it is to invest in the US once the favorable tax rules on business investment are phased out. It's even more unrealistic to think that Congress will reverse the lower tax rates for individuals while maintaining the low tax rates for businesses. The cost of reversing of both items would amount to about $100 to $150 billion of lost revenue per year, climbing to over $200 billion in less than a decade.

Since the large federal deficit is supporting or subsidizing private sector activity the new way to think about how the federal budget is impacting the economy is by adding Federal outlays and the deficit and comparing the aggregate total to the level of GDP. In 2020 the combined amount will be over 25% of GDP, and headed higher over the intermediate term, while the norm is closer to the low 20% during the latter stages of an economic cycle. Each additional percentage point (up or down) is worth approximately $250 billion.

Does it matter? The US is in a unique position in that it borrows in its own currency and can always print money to finance deficits. Meanwhile, the risks associated with operating with a high-debt load in the current environment of very low interest rates are relatively small, unlike the destabilizing effects on the economy if Congress would decide to reduce the deficit.

Yet, the "unbalanced" federal budget does create a new problem. For the first time in modern times, current projections by the Congressional Budget Office show that the federal budget deficit will continue to widen even when the economy is growing in line with its potential. And, the size of future deficits would only get larger if Congress decides to make permanent the favorable tax incentives for business and the individual tax cuts.

As such, the US budget is climbing into "uncharted territory" as it will generate a rising amount of debt every year. The US already ranks the 4th highest among developed countries in terms of government debt-to-GDP. At some point, it would not be big surprise if the credit agencies put the US on "credit watch" or even downgrade it, and the dollar's status as a reserve currency starts to get challenged even more.

Thus, there are several channels the "unbalanced" federal budget could eventually have an adverse effect on the US economy and financial markets, and risks of that eventual negative feedback loop occurring is not that far away.


Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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The Trump Administration, with support and consent from Congress, has cobbled together a lopsided federal budget, loaded with upfront stimulus, financed with huge borrowings, only to be reversed in future years with doubtful spending [...]

The Federal Budget--- "Unbalanced" Forever?

Charles Steindel

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The Philadelphia Federal Reserve Bank’s estimates of state coincident activity for June continue to show that most states are experiencing reasonably healthy growth. As was the case for May’s first set of numbers, the June results show that over the prior 12 months, 32 states had increases in their indexes in the 2 to 4 percent range. The outliers were also very similar to May’s, with Massachusetts the only big state on the high side, and Illinois and Michigan being the two big states on the low side. As has consistently been the case recently, Nevada was the h leader, with an increase a bit north of 5 percent. No states reported a 12-month decline (Michigan’s increase was the lowest—a meager .1%). In general, Western states appeared stronger than the East.

Over the three months ending in June West Virginia was again the leader, with a big 2.4% rise. Rugged terrain was clearly in favor, since Montana was second, Colorado third, and Vermont fourth! (Rhode Island, which if states were ironed flat would be even smaller compared to the other three just noted, was third). Of the 15 states with 3-month growth higher than 1 percent, 11 were in the west (New Jersey and Maine joined West Virginia and Maine as the fastest-growing Eastern states over this period). This western set included Texas and California. 13 states—mostly east of the Mississippi—had growth under .5% over the last three months, with Michigan’s index falling in that period. New York was in that low-growth group.

As was in the case in May’s initial round, Montana had the largest one-month increase in the initial results for June, well above second-place New Jersey (players of the original Atlantic City version of Monopoly should make note of how appropriate is for New Jersey to win second prize in this beauty contest). Only two states, Wisconsin and Kentucky, registered declines in the fairly erratic monthly results.

The June results continue to show growth appears stronger in the West than in the East. There had been some earlier indications that growth was becoming more uniform across the nation, but the West has apparently regained momentum relative to the East. Parts of the industrial Midwest look soft, most notably Michigan. However, we have reached the time of year that the comparison of this report with other data has become problematic. Data from the payroll employment report are the most important inputs to the coincident indexes. But while we will be getting word of the benchmark revisions in a few weeks, these will not be reflected in the state numbers until next March. Also, the indexes are calibrated to match trends in a state’s real GDP. From now until November, the state real GDP series will not themselves be consistent with the recently revised national GDP series. So the coincident indexes will be built from data whose revisions we have some reasonable expectations, and set to match data that is formally inconsistent with national trends.
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The Philadelphia Federal Reserve Bank’s estimates of state coincident activity for June continue to show that most states are experiencing reasonably healthy growth. As was the case for May’s first set of numbers, the June results [...]

State Coincident Indexes

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The happy prophecy of endless growth in the economy generating a continuous flow of strong corporate earnings just ran into trouble—the "truth" on profits. According to GDP data released today Q2 corporate earning posted their largest decline annual decline in several years, and the revised data shows that there has been no growth in operating profits for the past 5 years.

Q2 Real GDP bettered analyst's expectations growing 2.1% annualized, driven by strong gains in consumer and government spending. Yet, the gain in GDP did not flow to the bottom line for companies.

According to the preliminary Q2 GDP results, implied operating profits for the period totaled $1,900 billion, down 5% from Q1, which would represent the third consecutive quarterly decline, and off over 7% from the year ago levels, one the largest declines recorded in several years.

Yet, as ugly as the Q2 numbers appear to be on the surface, what are even more troubling are the sharp downward revisions for the last two years. According to the annual GDP revisions operating profits for 2017 were lowered by $93 billion, or 4.4%, and profits for 2018 were reduced by a whopping $188 billion of 8.3%.

The revised numbers of corporate profits show that operating profits peaked in Q3 2014 and have been moving sideways even since. Operating profits in the GDP accounts and S&P 500 operating profits over the long run track fairly close to one another, although there can be large differences in any given year. Yet, a flat trend for 5 years in operating profits should not be overlooked or ignored especially since during this period S&P 500 share prices have increased over 50%.

Operating profits, or profits from current production, are the purest form of corporate earnings since this series puts all firms on the same accounting framework and the profit numbers are not adjusted for the number of shares outstanding; the latter which is often reported by S&P 500 companies for equity investors.

The argument being used by equity analysts and strategists that the equity market is cheap or inexpensive relative profits appears to be dubious in light of revised data on operating profits, and it suggests that the "actual " market multiple is a lot higher than what is being reported by analysts.


Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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The happy prophecy of endless growth in the economy generating a continuous flow of strong corporate earnings just ran into trouble—the "truth" on profits. According to GDP data released today Q2 corporate earning posted their largest [...]

The "Truth" on Profits – No Gain in Operating Earnings for the Past 5 Years

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Real GDP growth by state continued to be centered in the West in 2019:Q1, although West Virginia's pace, 5.2% at an annual rate, was the fastest in the nation. Eight of the nine other states in the top ten were in the West, led by Texas's 5.1%--Delaware was number 7, at 3.9%. For comparison, in current dollars, Texas's GDP is more than 20 times the size of West Virginia's and more than 10 times the size of West Virginia's and Delaware's put together. Hawaii was the slowest growing state (a 1.2% rate), but two medium- to large eastern states were 48 and 49 (New Jersey and Maryland). However, three large Eastern states (New York, Ohio, and Georgia) grew at rates above 3%, while California's pace of expansion was only a moderate 2.7%.

State GDP estimates are derived by distributing national figures on industry output across the states. The sluggish growth rate of Maryland (and DC, which grew at a 1.4% annual rate) was likely closely connected to the partial Federal government shutdown; government output declines played a noticeable role in holding down aggregate output in both (there were other states that also saw marked declines in government output; Hawaii, though, did not see an especially large drop in government. Weakness in a broad array of private sectors accounted for Hawaii's poor showing). New Jersey was apparently held back by a decline in real estate output. Estimates of quarterly growth in that sector can be seen as problematic; the bulk of real estate output is the imputed income of homeowners—an especially large element of New Jersey's economy—and substantial quarterly moves could be regarded with some suspicion. West Virginia, as well as numbers of other large energy-producing states, mostly in the West, was buoyed by large increases in mining output.

The timing of this release is a little unusual. Tomorrow will see the first estimate of 2019:Q2 GDP for the nation as a whole, along with revisions to the numbers for the last few years. Thus, until the second quarter state GDP figures and revisions are released in November, the comparability of the state and national numbers will be weaker than normal.
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Real GDP growth by state continued to be centered in the West in 2019:Q1, although West Virginia's pace, 5.2% at an annual rate, was the fastest in the nation. Eight of the nine other states in the top ten were in the West, led by [...]

State GDP in 2019:Q1

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The Phillips curve has been dormant for over two decades, as the dynamic between tight labor markets and inflation has virtually disappeared. Yet, the demise of the Phillips curve should not be used as a reason for policymakers to think it is safer to run with a more stimulative monetary policy.

The transmission of modern day monetary policy works mainly through the asset markets and shifts the balance of risks towards asset cycles and financial stability. Decision to ease monetary policy today against a backdrop of record asset values would be tantamount to easing policy at the peak of previous high inflation cycles.

In testimony before Congress, the Fed Chair Jerome Powell acknowledged that the linkage between unemployment and inflation has been broken for at least 20 years. A number of fundamental and technical factors have come into to play in the past two decades to alter this relationship.

For example, in 1998 the Bureau of Labor Statistics (BLS) determined that it could no longer find an adequate sample of owner-occupied housing to safely ensure an accurate measurement of owners rent so BLS decided to rely exclusively on the survey data from the rental market to measure both owner's rent and apartment rents, even though the two markets are fundamentally different.

Measurement changes for technical reasons tend to be of minor importance but in this case the risk of altering the behavior of reported inflation as well as its relationship to other series was high for two reasons; first, the owner's rent is the single largest component, accounting for over 30% of the core consumer price index; and, second, it was being replaced with a rent series that tends to move countercyclical, or the opposite direction of house price inflation.

Here's a quick glance at how the owners rent series tracked housing prices under the original and new measurement practices.

During the 15-year period (1983 to 1998) when BLS used the original owner's sample, the owners rent index rose cumulatively 74%, nearly matching the 72% increase in house price inflation as measured by the S&P Core Logic Case-Shiller series. Yet, during the housing boom period of 2002-06 when house price inflation jumped 50%+, the new owners rent index showed a cumulative increase of only 15%.

The near disappearance of housing inflation from reported inflation is mainly technical, but it did contribute (a lot) to the breakdown in the Phillips curve. Meanwhile, the loss of the house price signal should not be interpreted that real asset inflation is any less important to the economy's performance or to monetary policy. Yet, from an operational standpoint for monetary policy the change moved housing inflation from the inflation-targeting bucket to the financial stability mandate.

Why is this important? Monetary policy feeds asset cycles through the same channels (interest rates and expectations) as it does general inflation. Yet, policymakers treat asset cycles differently believing that supervision and regulation---as a substitute for tighter money--- is a better approach to promote financial stability.

It is always difficult to prove causation but it's hard to deny the recurring pattern of boom/bust asset cycles ever since this two-prong policy has been used in the past two decades. Moreover, the tipping point for the last two recessions came from destabilizing excesses in the asset markets and not from imbalances tied to general inflation. Today's readings on asset values---relative to nominal income and GDP--- exceed those of the dot.com and the housing bubble.

Each generation of policymakers has had to deal with fundamentals changes in the economy, and with the changing transmission and channels of monetary policy. During the high inflation cycles of the 1970s, policymakers misread inflation dynamics leading policymakers to believe that by accommodating the inflation cycle it would extend the economic cycle. That did not end well. Are policymakers nowadays falling into the same trap, misreading the dynamics of asset cycles believing that by promising more easy money it will help extend the economic cycle, while overlooking the risks to financial stability?

The Phillips curve might be dead, but its "ghost" lives on in the "Asset" curve (or the new dynamic between monetary policy and asset cycles). Policymakers should proceed with caution.


Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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The Phillips curve has been dormant for over two decades, as the dynamic between tight labor markets and inflation has virtually disappeared. Yet, the demise of the Phillips curve should not be used as a reason for policymakers to [...]

Demise of Phillips Curve Shifts Focus to Asset Cycles and Financial Stability

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The June job numbers from the states, like the national figures, showed increases, but except in a few instances these were not statistically significant. Only 4 states reported statistically significant gains—but these included California’s 46,200 and Texas’s 45,000 (Georgia and Tennessee were the other statistical gainers). Ten states reported declines; for the most part these were not only statistically insignificant but also seem trivial in magnitude (Maryland’s 7,000 drop and Nevada’s 4,000 decline are the exceptions). 49 states, plus DC, reported higher payroll employment in June 2019 than in June 2018, with 28 of these gains being seen as statistically significant. The one state seeing a drop in jobs over this period was Louisiana. Despite the decline in June, Nevada again led the nation in 12-month job growth, but June’s 3.3 percent figure was lower than some reported in recent months by the Silver State. In general, the states with the strongest job gains over the last year were in the West. Florida was the only Eastern state with growth above 2 percent, as compared to six in the West.

Unemployment rates remain at what had been regarded as almost unbelievably low levels. Again, Alaska was the high-side outlier, with its rate staying at 6.4%. DC was at 5.6%; no other state was as high as 5.0 percent. Vermont continued to have the lowest figure, with its rate staying at 2.1%. The vast majority of states had unemployment rates between 2.5% and 4.5%. An odd anomaly, given the strength of its job market, was the 4.6% of Washington state.

Puerto Rico has recently been back in the news. While the stories now focus on political turmoil, the underlying backdrop of a troubled economy continues. The island did report a drop in its unemployment rate in June, to 8.4% (quite low by Puerto Rican standards), even though the labor force grew , and there was an increase in payrolls. While the number of private-sector jobs is now a bit above its pre-Maria level, due to a marked contraction in government employment, the overall job count is still under the pre-storm mark.
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The June job numbers from the states, like the national figures, showed increases, but except in a few instances these were not statistically significant. Only 4 states reported statistically significant gains—but these included [...]

State Labor Markets in June

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Preemptive actions is an important feature of monetary policy, but policymakers have never made a preemptive move when the economy's actual performance has been so closely aligned with the Fed's own expectations or when the financial markets were so robust. If the Federal Reserve lowers official rates at it's July 30-31 Federal Open Market Committee meeting it would be done based on the view that a modest "preemptive" move now would obviate the need for larger actions later. Yet, the counterargument is that adding liquidity against a backdrop of overly accommodative financial conditions is precisely the tinder that ignites bubbles.

At the December 18-19 2018 Federal Open Market Committee meeting policymakers revealed their forecasts for 2019; 2.3% gain in real GDP, a 3.5% end of year unemployment rate and core inflation of 2%. And based on those economic and inflation forecasts policymakers had anticipated hiking official rates twice (in increments of 25 basis points) over the course of 2019.

During the first half of 2019 the real economy grew 2.3% annualized (averaging the 3.1% growth of Q1 with the 1.4% estimate for Q2 based on GDPNOW forecasting model of the Federal Reserve Bank of Atlanta), the unemployment rate sat at 3.7% in June and the core consumer price inflation increased at an annualized rate of 2.1%. Despite a near home run in all of its forecasts policymakers are now considering lowering official rates. What changed?

One of the arguments that has been advanced is that some policymakers are worried that the consistent undershoot of the 2% inflation target creates the potential for consumer inflation expectations to become unhinged, hindering the effectiveness of monetary policy.

The first problem with that argument is that monetary policy can influence the degree of liquidity in the system, but it cannot guide its direction. The fact that of the monetary liquidity is being channeled into the asset markets (which are not part of the targeted inflation index) does not mean policy is ineffective or that rates need to be lowered to hit an arbitrary inflation target. Given the complexity of the economy and the imprecision in price measurement hitting a 2% target would occur more by luck than by design.

The second problem with that argument is that either consumer's are unaware of the Fed's 2% target or that their actual experienced inflation consistently runs higher than reported inflation. Surveys of consumer inflation expectations have consistently shown that people expect more inflation than the 2% target, and only twice (for a very short spell) in the past 20 years did expectations dip below 2% mark and both of those occurred during a crisis (9/11 and Great Financial Recession).

Another argument advanced by the Fed Chairman Jerome Powell is that the economy is facing a lot of crosscurrents. Crosscurrent is another way of saying that some sectors and industries in the economy are growing and others are not. But that's always true. The Bureau of Labor Statistics includes in its monthly employment report a diffusion index, measuring how many industries are hiring month over month. In normal times the diffusion index runs between 60% to 65% ----which implies an increase in hiring for a broad range of industries but also a large group that are not hiring as well. The June 2019 diffusion index reading stood at 60.7. Normal times?

Monetary policy is about to enter unchartered territory. Preemptive easing policy actions in the past have been taken when sharp sell-offs in equity markets or stress in the credit markets had the potential to generate adverse economic outcomes. None of those conditions exist today; if anything, financial conditions are too relaxed.

Preemptive policymaking requires a constant and broad assessment of economic and financial conditions so not to risk over doing it one way or the other. Equity prices should figure prominently in this monitoring process since equity prices offer signals on future growth but they are also a receptacle for excess liquidity. The sharp rise in equity prices over the first half of 2019 should tell policymakers that the problems the economy faces are non-monetary related and lowering official rates is not the appropriate policy response. The danger in promising more easy money is that equity prices rise to unsustainable levels creating bigger adjustment risks to the economy that presently exists in low inflation and crosscurrents.


Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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Preemptive actions is an important feature of monetary policy, but policymakers have never made a preemptive move when the economy's actual performance has been so closely aligned with the Fed's own expectations or when the financial [...]

Preemptive or Bubble-Making Monetary Policy

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.