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The Roaring 2020s Express Train
Why is the stock market continuing to make new highs? It's doing so because corporate earnings are doing the same, as the economy continues to speed along without stopping for a recession. The latest batch of data certainly drove the stock market higher today, confirming that we are still riding the rails on the Roaring 2020s Express. Nothing seems to stop or derail this train. (1) GDP. The US economy grew at an inflation-adjusted annual rate of 2.0% in Q1 (chart). Final sales to private domestic purchasers, the cleanest read on underlying demand, came in at a solid 2.5%. Business investment surged at its fastest pace in nearly three years, driven by spending on AI-related equipment and software. Exports jumped sharply. Consumer spending was up only 1.6%, probably because the weather was very bad during January and February. It should grow faster in Q2. The big drag was imports. Our homemade real GDP growth model suggests that the pace of economic activity picked up in March and April, along with the growth rate of S&P 500 forward earnings (chart). (2) Consumer Spending. Real disposable personal income (DPI) dipped slightly in March as the energy price surge eroded nominal income gains (chart). Real DPI has been relatively flat over the past year. Yet inflation-adjusted consumer spending is still growing. We attribute this development to the retirement of Baby Boomers. Because spending growth outpaced income growth in March, the saving rate fell to its lowest level since October 2022 (chart). Retired Baby Boomers are dipping into their record-setting retirement savings now that they are no longer receiving labor income. The details of real consumer spending in March reveal that goods spending led broadly while services stalled. Energy was the steepest decliner, consistent with higher gasoline prices weighing on demand. The Redbook Retail Sales Index shows that such spending continued to grow at a solid pace in April (chart). (3) Capital Spending. Capital spending indicators are red hot. Nondefense capital goods orders and shipments excluding aircraft hit fresh record highs in March, with both series in a strong uptrend since 2024 (chart). Intellectual property (including software) and business equipment investment (including semiconductors and servers) both hit record highs in Q1-2026. They have been on strong uptrends since 2020, while structures continue to lag meaningfully behind (chart). Software, information processing equipment, and R&D also reached fresh record highs in Q1-2026. The pace of growth in information processing equipment steepened significantly recently amid the AI-driven investment boom (chart). High tech's share of total nominal nonresidential capital spending surged to a record high of 55% in Q1-2026 (chart). (4) Labor Market. The labor market delivered a blockbuster reading this week. Initial unemployment claims dropped to the lowest level since 1969, confirming that layoff activity remains remarkably subdued. Continuing jobless claims are also falling (chart). The recent drop in initial jobless claims suggests that the unemployment rate likely fell in April (chart). The Q1 Employment Cost Index came in hotter than expected, but the composition is important. The acceleration was driven by a surge in benefits costs, specifically, employer-sponsored health insurance reflecting the expiration of ACA subsidies. Both average hourly earnings and ECI wages & salaries have cooled significantly from their 2022 peaks and are now broadly converging near pre-pandemic norms (chart). (5) Inflation. Headline PCED inflation spiked in March, driven by the energy price surge (chart). Importantly, core inflation is also moving further away from the Fed’s 2.0% y/y target. Goods inflation has re-accelerated sharply, reflecting the energy price shock and tariff pass-through, while services inflation remains stubbornly sticky (chart). The re-acceleration in goods inflation is being led by nondurables, especially energy (chart). Durable goods inflation has also been moving higher since Trump's tariffs were imposed early last year. There is no sign that the tariff effect is dissipating so far. Housing services inflation continues to gradually cool, but services inflation ex-housing and ex-energy suggests little progress on the last mile to the Fed's inflation target (chart). (6) Miscellaneous. US crude oil exports may be starting to take off to fill the supply gap caused by the blockades in the Arabian Gulf (chart). The US economy is handling the energy shock better than the Eurozone economy according to their Citigroup Economic Surprise Indexes (chart).
On Consumer Spending, Rental Markets & Crypto
Consumer spending doesn’t seem to have let up despite higher gas prices and greater geopolitical uncertainty stemming from the war in the Middle East. That’s the view from the vantage points of both Hilton and Visa execs, Jackie reports. Both companies had strong March quarters and are optimistic about the remainder of 2026. … Also: A post-pandemic apartment construction boom oversupplied the market, and rent inflation has decelerated significantly as a result. But much slower new supply growth going forward should firm the market, says AvalonBay. … And: The line is blurring between banks and cryptocurrency companies, each expanding into products and services traditionally offered by the other.
No More Mr. Nice Guy
We will miss Jerome Powell's chairmanship of the Fed. He is a nice guy. He did the best that he could as Fed chair from February 5, 2018, through May 15, 2026, when his term as chair expires. Nevertheless, he said he intends to remain a Fed governor for now. He can do so until his term on the Board of Governors expires on January 31, 2028. President Donald Trump doesn't share our affection for Powell. He certainly wasn't nice to Powell. In any event, Trump focused more of his wrath on Iran today. The President posted a message on Truth Social expressing frustration with the stalled nuclear negotiations. He urged Iran to "get smart soon" and explicitly wrote, "NO MORE MR. NICE GUY!" Reports from yesterday and today indicate that Trump has instructed his aides to prepare for an extended blockade of the Strait of Hormuz and Iranian ports. During a Situation Room meeting on Monday, he reportedly opted for this "prolonged squeeze" over more kinetic military options (like resuming bombing) or walking away from the conflict entirely. Secretary of State Marco Rubio noted earlier today that while the blockade is the current "safer" primary lever, the administration still has plans for "surgical" strikes in reserve should the deadlock continue. The prospect of a prolonged stalemate—albeit with a ceasefire and a possible resumption of the shooting war at any time—pushed oil prices higher to around $110 a barrel this evening. The stock market took it in stride with a 0.3% drop so far this week (chart). On April 21, we (belatedly) recommended overweighting the S&P 500 Energy sector as a hedge against a prolonged blockade of oil from the Arabian Gulf. XLE is up 5.7% since then. The bond market is starting to signal concerns that the energy shock might cause a more persistent, rather than transitory, inflation problem. The 10-year Treasury bond yield is up from 3.95% on February 27 (a day before the war started) to 4.25% this evening (chart). The widely used proxy for the 10-year expected inflation rate accounts for most of the increase. The Bond Vigilantes are starting to mutter: "No more Mr. Nice Guys." We've been predicting a 4.25%-4.75% range for the 10-year bond yield this year. The yield is likely to rise to 4.55% in the next few days (chart). Contributing to the upward pressure on the bond yields is the Fed’s hawkish decision today to hold the federal funds rate where it is. It may be a preview of the divided institution Kevin Warsh is about to inherit. No more nice guys and gals on the FOMC. Consider the following: (1) A committee split down the middle. A supply shock is the hardest environment for a central bank to navigate. It pushes inflation up and growth down simultaneously, and different FOMC participants will naturally lean in different directions in response. Today's vote showed exactly that. The FOMC divided along the widest lines of dissent in decades. Governor Miran voted for a quarter-point cut. The other three dissenters (Kashkari, Logan, and Hammack) supported the hold but pushed to remove the easing bias in the statement entirely, arguing that the next move is as likely to be a hike as a cut. Warsh is walking into a divided committee, which will make it very difficult for him to advocate successfully for rate cuts. Not surprisingly, the federal funds rate futures market turned slightly hawkish today on the outlook for the Fed's policy rate over the next 12 months (chart). (2) Rates on hold through year-end. Today's decision reinforces our conviction that the federal funds rate won't move in either direction through year-end. Inflation risks have clearly increased. Powell noted that higher energy prices will push up overall inflation in the near term, a direct consequence of the closure of the Strait. At the same time, the US economy has shown considerably more resilience than most had anticipated, reducing the downside labor market risks that previously justified an easing bias. Why not hike? Because rising energy prices have not yet seeped into underlying inflation. Long-term inflation expectations remain anchored, limiting the risk of a self-reinforcing price spiral. The economy does not need a cut; inflation does not yet demand a hike. The Fed is in a holding pattern, and we expect it to stay there. (3) Powell is not going anywhere. Powell confirmed that he will remain on the Board after his chairmanship ends on May 15, until the now-dropped DOJ investigation is "well and truly over, with transparency and finality." He outlined the need for assurances that the case will not be reopened absent a criminal referral from the Fed's own Inspector General, and he made clear that his decisions will be guided "entirely by what I believe is in the best interest of the institution." He is a nice guy. Leave him be.
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