Rodney Johnson's July Economic Update
This article is a transcription of Rodney Johnson's Economic Update, which took place via Zoom on 7/27/23. The video can be found at the end of this article.
GDP Flow Through the Decades
I want to start with GDP growth. And GDP, actually, second quarter GDP, was announced today. It's the first estimate, as they call it on the fourth, the third is today following the end of the quarter. So don't worry about that. It happened today, and it was for March to June. So, if you look at GDP, it's better to think of it over the really long term. If you look at this chart, it's late 1940s through 2023, you'll see that it was really bouncy in the early years, because the economy was bouncing, right? I mean, we had a lot of things going on industrial wise, making a bunch of cars and then sending stuff overseas after World War 2. It's going from 0 to 5 and a half to 7%, and then back again. And then you get into the 80s and 90s, and it's much more stable. It's around 4 to 5%. And that was a pretty good time, the late 80s. And in the 90s in particular, this productivity was hot. We were getting a lot out of the next person in the economy.
Source: Federal Reserve Educational Database
Then you get into the early 2000s, and productivity kind of fell away. GDP is down around 3 to 4%, and then you get into the 2010s. It really was a lost decade for the economy when we got to 2% in the decades leading up to the 2010s. If we got to 2% GDP, we were pretty much guaranteed to go into a recession, but we spent an entire decade sitting around 2 to 2 and a half. It was just kind of boring.
Source: Federal Reserve Educational Database
And then, you get COVID showing up. GDP drops like a rock. We spend trillions of dollars. It runs to the moon, and then it comes back again. And here we are in that 2 to 2 and a half percent range. And so, if you look at just the last several years, 2019 through 2023, you'll see that that's exactly where we are, right back to that two-ish percent range. That does not scream growth. It's okay; I'm glad to have it instead of a recession. But it doesn't scream great growth. People on this call, and certainly, Chris and company have heard me say this for a long time, I didn't think we were going into recession, but if we did, it would be the best recession you've ever seen, because it would be shallow. And the reason is, everybody is still working. And so, if everybody is still working, they're going to spend the money. They may not have as much because inflation is eating it away, but they will spend the dollars. it just won't feel all that good.
We're not getting any productivity punch that you normally get when you go through an economic season like this, where you get what looks like going into a recession. People fire a bunch of workers, and then they automate, and then they only bring back exactly what they need in terms of employees. We're not getting that normal term. And so, we're not getting the productivity growth, and we still have some inflation. And that's the other part of this. While growth is kind of muted, inflation is still here. We got the inflation numbers earlier this month, and it was down to 3% on the headline. That's great. But it didn't go negative, and that's a big thing. The last quarter, the Atlanta Fed GDPNow model were telling us that we should get about 2.4% inflation. Guess what? That's exactly what happened. This model continues to be a very good indicator of where we're headed in terms of GDP. It is one of the main reasons that I was looking at the numbers and questioned whether or not we were going to get this big recession everybody was calling for because this model didn't show it. And it's like, 'Well, you know, I don't see it either.' And so, we got what we thought.
Source: Atlanta Federal Reserve
The Fed vs. Inflation
When you get to the inflation side on the numbers a couple of weeks ago, this is a headline inflation. Again, you look through the 2010s, and it was kind of muted. It was 1 to 3, mostly in the 1 and a half to 2 range, not closer to 3, and so it was just as muted as GDP. As I said, it's kind of a lost decade when you look at it historically. We got the big pop after COVID, after we pumped money, a lot of money, into the economy. But then they rolled over. We're at 3. But that's 3% on headline core is still 4.2. This is the thing that is keeping J. Powell and the other central bankers up at night. They are looking at this and saying, 'Okay, I get it. It's following. It's still 3% after being up around 9 and a half or so.' This is not good because people's incomes are not rising like this. And so, our standard of living is declining.
Source: Federal Reserve Educational Database
The thing about inflation is, it doesn't hit you like the chart hits you. The chart hits you because they're averaging all the changing numbers for food, or this, that, whatever. And okay, so we pay more at the gas station. That's pretty immediate. And when inflation fell recently, it's because we paid less at the gas station. That's pretty immediate. But there are a lot of other things that go into this that hit us only when we need something in our personal economy. This is the one that J. Powell and others were looking at when they said yesterday, 'Look, we're raising rates, but we don't know what we're going to do the next time.' They just don't. They said it's a coin flip; they could either raise rates, or they could leave them pat at the next meeting. That, in itself, is a decision, because they could do 3 things: They could raise rates, they could stand pat, or they could lower rates. They took that off the table a long time ago. They have been so crystal clear, 'We are not at a point of lowering rates this year.' They're just not.
Source: Federal Reserve Educational Database
I think there are some things coming that are going to soften the economy some, but I don't think that's going to change their mind. And, as I've said for a long time, when the Fed talks, our job is to listen, pay attention to what they're telling you. If they're telling you that they're not going to take the foot off the gas, they're not necessarily going to speed up, but they're not going to slow down. Then we can expect low, very short-term rates to remain high, probably through at least the end of this year. This is inflation following, but not rolling over. And that's the thing. If you look at what happened, this is inflation during the 2010s, and then the 2020s, of course, and you see that long slope higher, and then this pop. If you break it out, it took 9 years for prices to increase by 15 and a half percent from 2011 to 2020. It took 15 months for prices to climb the same amount, 15 and a half percent, from 2021 through the middle of 2022. That is a huge, huge growth rate in a very short period of time. And my point is, we're going to see it for years to come as we work it through our personal budgets.
Inflation's Effect on a Personal Budget
A great example is: My son called me a couple of days ago, and he said, 'Hey, we need a car. My wife has a car, but she wants a new one. She wants a Suburban; not necessarily a new one. Of course, they're not going to spend $80,000 on a Suburban. But she wants one; she's willing to take a used one with some miles on it, and this and that. You have a lot of Suburbans in Texas.' Yes, we do. We can't go 6 feet without running into a Suburban. And I happen to have purchased a brand-new Suburban in 2005 and drove it right off the lot for $35,000. I loved that truck, and I drove it 180,000 miles, and we got rid of it in 2016. I'm a big fan. And so, when he says he wants a Suburban, I'm all about it. They're about to have 2 kids and everything. And so, I was looking around, and I found one that I was going deal with for him, and then have it sent over to San Diego. And he is thrilled to get a 6-year-old Suburban. It's the same trim as the one I had purchased back in 2005, with 47,000 miles for $36,000. The same price I paid back then. Now I know it's been 17-18 years, but this car would have been easily $10,000 less in 2020, easily.
And so, this is a huge move in inflation that I have not experienced in my personal budget because I have the same cars as I did 4 years ago. But when I go to buy a new one, I'm going to be cranky. I know I am, and people are as they have to go through and pick up these pieces that have suffered a lot of inflation. And so, we just have to understand that people are going to be dealing with this for several years to come, as it works its way all the way through the system. We need to watch out for hidden inflation. I call it hidden, it's not really.
I went out to dinner the other night to a restaurant I've been to a number of times since we moved here 5 or 6 years ago, and I noticed at the end, when I got the bill, that my iced tea cost $3.79. Now I don't know what yours is where you live, but I do know that ours was just a little cheaper a year or 2 ago. And so, because everything on the planet, historically, is online, I went and found one of their menus from 2019, and in 2019 a glass of iced tea cost $1.99. What I know is, iced tea is not 100% more expensive today than it was in 2019. But you know, you charge where you can. I don't blame this restaurant for what they're doing. I know it's easy to tack another 50 cents or buck onto a drink, because everybody orders one and they have increased labor costs and all the things to deal with it. But it's one of those things where you look at the meal and yeah, it got a little bit more expensive. But at the end you get this little nasty surprise, and it's like, 'I did not see that coming.' Because I did not. And so, it's not hidden, and I don't think they're doing anything wrong, it's just something that we're going to be paying, there's no question.
Inflation's Effect on the Housing Market
Homes are quite a bit, and we've been talking about this, too. Homes are expensive, and they have some of the same qualities as cars, right? And that labor went higher and supply, or rather, the inputs have been increasing in cost. The big thing we have with houses is no inventory, which we all know, that's not a surprise and it's not likely to let up. I bought this house a few years ago. I think I have on it 3% or 2.7%, or something. If I was hemmed in by that, then I would have a real problem moving, because my next home would have a financing cost so much higher, right? To go from 3% to 7%, that's a really big deal. Not only do I have to pay for it, but I also have to qualify for it; I think about that. A lot of people in homes won't qualify for the next mortgage, because the cost is so much higher. And so there are a lot of considerations, which is why I don't expect inventory to go up anytime soon for existing homes.
Source: Federal Reserve Educational Database
Which is why builders are doing so well. I mean home builders can't build fast enough in the areas that people want. There is about 7, 7 and a half months' worth of supply of new homes, but still they're selling like hot cakes. There's no question builders are having a field day right now, and if they could build more $400,000 homes, you know they would in a second. They just have to find the land where it makes sense.
This chart shows you the price of new homes, which is in blue. And then it's existing home sales in red. The red line is very short because the Fed just started charting this. National Association realtors have done it for a long time. The thing to get out of this is the prices converged; they're both right around $410,000. I know that new home prices shot to almost $500,000, but that gets skewed by what the builders will build. If everybody is wanting to buy a $750,000 - $900,000 home, that's what the builders are going to build. And so, the existing home is where you get a good look at the overall market in terms of price. Watching the new home price fall does not imply that they are not selling because they are selling what they can make, it implies that that level of the market, that strata of the market, is desperate for homes that they can't find. And it's, of course, first time home buyers.
To give you a sense of this, new homes currently make up 30% of the market for home sales. Typically, new homes make up about 10, maybe 11%. For new homes to make up more than 30, I think it's actually 32 and a half, but to make up 30 is a huge, huge thing. The only way this changes is if rates come down so dramatically that long rates fall dramatically, and mortgage lenders feel comfortable bringing down mortgage rates dramatically. I just don't see that. If you've spent a decade with rates very, very low, and then they pop against you, which is what happens, if you're a mortgage lender and rates go high, then all the mortgages you have outstanding are now underwater from your standpoint as a lender. The last thing you're going to do is follow rates lower very quickly, if they fall. You're going to take your time and go from 7 to 6 to 5. You're probably going to sit at 5 for a long time before you get under that. And so, a lot of people at 3% are just going to say, 'You know what, it's not worth it. I'll just sit right here and be happy.'
The Fed's Rates
The Fed were very specific yesterday. They will not be raising rates any time when soon. We all know it's about the Fed, right? They raised rates from 5 and quarter to 5 and a half on the top end. And they said, they're data dependent; well of course, they're always data dependent. The real thing is, they said, they're going to be in inflation, and they left no room for this conversation because they don't want it. They don't want investors to have any sense that they're going to lower rates anytime sooner. But it's not just investors. They want all of us as consumers to be confident that they're going to have inflation under control and at their target of 2% very soon. What the Fed cannot risk is that you and I believe that inflation at 3% will be persistent, or perhaps could go back up, because that means that we're willing to spend the extra money to buy stuff at higher prices.
I know it sounds like a weird thing. But that view of future inflation is what they're trying to bend. They're desperately trying to curve our notion of what's going to happen in the future with prices so that we start telling our retailers and sellers of all kinds, 'I'm not going to buy at that price. It's too hot. I'm going to wait till prices come down.' They need us to be the sheriff in town that essentially rides her over the retailers, so the prices don't go up anymore. They know the same thing I do, that 15% in 15 months that I showed you, it has not worked this way through the system. It just hasn't, and as it does, people are going to feel a lot of pain.
The 'Twos and Tens' of Treasury Bonds
Chris had asked me about the twos and tens. There's a common thing in the bond world where you compare the rate of interest on a 2-year treasury bond to the 10-year treasury bond. So, it's called the twos and tens. People look at that spread to judge where we are in the bond world, more or less. It's supposed to be in the normal world, if you lend money to the Government for 2 years, you want to get paid and call it 2%. I mean, I know right now it's about 4 to 4 and a half, but call it 2%. And normally, if you lend money for 10 years, you want to be paid more than that, so call it 3%. So, there would be a 1% differential between the two. That is not where we are right now. As a matter of fact, you get paid about 4 and a half, I think almost 5% on a 2 year, and you only get paid 3.8 on a 10 year. You get paid more for lending the government money for 2 years than you do for 10, which is totally upside down, which is the inverted yield curve. The chart here shows the 10-year treasury yield in red and the 2-year in blue, and you can tell the whole time that this goes back to 1960. It's almost always this way, because it should be. It does get inverted from time to time, but not very often. The twos and tens in 2009 to 2023 is just a closer look. We've got a 1 to 2 spread for most of the 2010s. They're on top of each other as the economy was getting shaky in 2019 and as the Federal Reserve was selling bonds.
Source: Federal Reserve Educational Database
But then we get after COVID, and you know the 10 year is going up some, and the 2 year is near 0 until the Fed started raising rates. The Fed raised rates so far, so fast that the blue line, the 2 year is now about the red. And so that's what everybody is telling you that it can't continue because it would invert the logic of investing where the longer you invest, the more you should be paid for putting your money to work, and that's just a lot. And so, they were saying, this inversion has to work its way out. There's a couple of ways that can happen: Either the 10-year bond yield could shoot above the 2-year, the 10-years at 3.8 or 3.85 could go up to 6 and a half or 7. Nobody wants that to happen, because if we have the 10-year at 6 and a half or 7, you're looking at mortgages at 8 and a half. That is not what anybody wants. I mean, you're closing in on 9, 9 and quarter, and that would be a very, very painful environment. Instead, what everybody believes is eventually the Federal Reserve will lower rates, and when they do, they're going to lower them at such a rate and to such a level that it falls below the 10-year. And so right now the Feds at 5 and quarter to 5 and a half have got to lower rates by one and a half percent to even get close to the 10-year. We've got some time before this cleans up. The most common way for that to happen fast is if we have some sort of issue in the economy to where the Federal Reserve says, 'Hey, wait a second, we're going into a recession, and we're going into it fast. We need to go from 5 and a half to 3 at this meeting.' And that can't happen, and it does happen. I don't see that over the next quarter or 2; maybe by next summer we'll have a jolt to the economy or something but we're going to have to wait for them to lower rates before this cleans up.
Source: Federal Reserve Educational Database
If you look at that as one graph, if you subtract the twos from the tens, you get this graph that shows you that relationship. It's usually about 1%, it can be lower, it can be near 0, which it was a couple of times, which is back to 1976. During the early 80s, it was below 0, and it was just crazy bouncing all around. But that's when long bonds were 10% but the short bond was 18%, which was really crazy with the inflation back then. Usually, it looks more like what you see here in the 90s, and then the 2000s where we'll get into something like 1987, October of 87, and rates fall like rock. Then you get in 2000-2002, same thing happened again, and in 2008-2009. We don't have a recession right now, but we definitely have an inverted curve. And so, it'll be interesting to see what happens.
Source: Federal Reserve Educational Database
Debt Repayment
There's something out there that I'm watching, and people are starting to talk about. I think I wrote about it with you. I certainly have written about it several times. We're asking (actually banding together to say) that student loan borrowers need to start their repayment. Last I saw it, it was the end of August, but I think somebody told me that they moved it to October. But whatever it is, it's 27 million borrowers, and the median payment is around $250-$300. This is real money that people use for whatever they want, and younger people tend to be the ones that have a balance, right? We could see a very soft retail environment as we get into the fall and the holiday season, because we've taken that money that was used for spending over the last 3 and a half years, and we're saying it has to go back to the government in terms of debt repayment. So, I don't think that would push us into recession, but it would make Christmas a lot less fun.
Watch the recording of Rodney Johnson's Economic Update here.
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