Charles Steindel

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The April results for the Federal Reserve Bank of Philadelphia's state coincident indexes were as horrid as one would expect. Only 4 states (Arizona, Georgia, Texas, and Nebraska) had one-month declines smaller than 10 percent (Arizona's was 5.5 percent); 8 had drops larger than 30 percent (Michigan was down 44.2 percent). Three-month results were comparable. On its web site the Bank puts up a map illustrating the three-month results. States with declines larger than 1 percent are shown in red, and that is what one sees—all 50 in red.

There is an oddity, though, about the results. There is a separate index for the nation as a whole compiled using the same data and techniques as for each state. The national index fell 12 percent from March to April, which was noticeably better than state norms. Only 8 states had declines less than that; the 4 noted above, as well as Colorado, Florida, Wyoming, and Mississippi. Of course, Texas and Florida are 2 of the 4 largest states, and Georgia is also big, but given the huge declines elsewhere a national drop of as “little” as 12 percent was surprising. In the current environment, though, the margins of error in both state and national results may be much larger than in ordinary times.

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The April results for the Federal Reserve Bank of Philadelphia's state coincident indexes were as horrid as one would expect. Only 4 states (Arizona, Georgia, Texas, and Nebraska) had one-month declines smaller than 10 percent [...]

State Coincident Indexes in April

Joseph G. Carson

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The Fed's debt-bridge policy is designed to improve the flow of credit to businesses to avoid a devastating credit crunch. Never before has one of the monetary policy solutions to combat recession been to extend credit to struggling, profit losing businesses.

There is no precedent for record business borrowing during a recession. The scale of business failures during and after the economy exits recession will far exceed that of the Great Financial Recession.



The Fed's Debt-Bridge Policy 

The traditional way for monetary policy to build a bridge from recession to recovery is through the lowering of official interest rates. In time, the reduction of interest rates triggers a refinancing cycle, lowering interest costs, and improving liquidity positions. The "reliquification" process enables firms (and individuals) to exit recession with stronger liquidity and lower debt burdens.

With official interest rates relatively low the "reliquification" process was not a viable policy option to combat the abrupt contraction in the economy. So policymakers were forced to support the flow of credit to the economy by purchasing securities and provide direct financing to sectors where it is not otherwise available or too costly.

So instead of contracting, which is the typical pattern during the recession, the flow of private credit has exploded to the upside.


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Since the start of 2020, commercial and industrial loans have increased over $750 billion to a record $3.1 trillion. That increase nearly matches the cumulative increase in corporate bank borrowing of the past 6 years.

At the same time, US corporations have tapped the capital markets for hundreds of billions of new debt. Through early May corporations have issued nearly $300 billion in new debt, twice as much as the comparable period one year ago.

An addition of $1 trillion of new liabilities over a few months is a big number in the best of times. Yet, record corporate borrowing during bad times increases the risk of business failures and defaults. Here's why.

A Harvard Business study released in 2010 analyzed corporate performance during three global recessions from 1980 to 2000. Sales and profit performance of 4700 public companies were analyzed three years before and three years after the recession.

The findings paint a grim picture of the devastating and lasting impact recession has on corporate performance. To be sure, a shocking seventeen percent of the companies failed were acquired or decided to go private.

Meanwhile, three years after the recession forty percent of the companies hadn't recovered to precession sales and profit levels. And, approximately 80% of public companies had not rebounded to their pre-recession growth rates in sales and profits a full three years after the recession.

Almost all business people agree that the current crisis marks an inflection point. The business world has changed and firms need to remake (i.e., downsize) their organizations to fit in the new normal. Companies will operate with a smaller footprint, but more debt.

There is no precedent for record corporate borrowing during a recession. As a result, investors need to brace for an economy unlikely to resemble the one before, with an uneven and slow growth, and record corporate failures.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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The Fed's debt-bridge policy is designed to improve the flow of credit to businesses to avoid a devastating credit crunch. Never before has one of the monetary policy solutions to combat recession been to extend credit to struggling, [...]

Something's Wrong: A Debt-Financed Recession

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The debacle was complete. All 50 states (and DC) experienced statistically significant declines in payroll employment and statistically significant increases in their unemployment rate in April. 43 states saw new record highs in unemployment, based on the current series (starting in 1976). Nevada was highest, with a truly staggering 28.2 percent figure. Michigan and Hawaii also had rates above 20 percent. Seven states report rates under 10 percent; Connecticut's 7.9 percent was the lowest. However, with a 7.4 percent drop in its labor force the Nutmeg State really doesn't have much to boost about.

On the job side, Michigan's count fell more than 20 percent. California, New York, Texas, and Florida all shed more than 1 million jobs. The rate of decline was Oklahoma's 7.8 percent; nine other states experienced losses less than 10 percent.

A sharp drop in government employment was noted in the national data. The experience of states varied substantially. Hawaii and Wisconsin shed more than 10 percent of their government jobs, but numbers of other states had losses of less than 3 percent. Leisure and hospitality, of course, fell greatly everywhere. Unsurprisingly, some of the most severely locked-down states, such as Washington, New York, and New Jersey, lost more than half their jobs in this sector (as did Hawaii and few other states—surprisingly, Florida and Nevada were not in this group).

For a second straight month BLS was unable to compile household survey figures for Puerto Rico. The island's job count fell by more than 10 percent.

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The debacle was complete. All 50 states (and DC) experienced statistically significant declines in payroll employment and statistically significant increases in their unemployment rate in April. 43 states saw new record highs in [...]

State Labor Markets in April

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In April, federal withheld income tax collections posted a record drop from year-ago levels. The scale of the decline indicates that the reported figures on job loss and unemployment are understating the
 collapse in labor markets. How many companies have ever stress-tested their sales plans for a 25% to 30% jobless rate? What's the new normal level of consumer spending?

 Federal Tax Receipts Tank 
In April, federal withheld income (gross) tax receipts totaled $79.6 billion, off 30% from year-ago levels. The scale of the decline is the largest on record since the monthly data started
 being reported in 1972. Before the April 2020 tax data was released, the largest monthly year on year decline in
 federal withheld income tax collections occurred in September 2009, off 21.7%, at the end of the Great Financial Recession. April tax receipts indicate that as ugly as last month's jobs report was it may have understated the scale of job loss and rise in unemployment.
 
 In April, the household employment survey showed that 22.4 million people lost their jobs, lifting the unemployment rate to 14.7%, up from 4.4% in March, an increase of 10.3 percentage points in one month. The one-month increase was larger than any annual
 increase on record, even during the years of the Great Depression. One of the curious parts of the April employment report was the exodus of 6.4 million people from the workforce. If people did not exit the workforce in record numbers last month, the jobless
 rate would have topped 18%. Confusion over new federal legislation for unemployment compensation may have led people to misstate their labor force status last month.
 
 Congress passed the Coranavirus Aid, Relief, and Economic Security (CARES) Act in late March. This legislation provided an extra $600 weekly payment in unemployment compensation; increased the number of weeks an individual may receive benefits; and expanded the coverage to self-employed and individual contractors who traditionally were not eligible
 under state law. Initially, states were waiting for updated guidelines from the Labor Department eligibility issue. Now that states and people are better informed about the eligibility issue people that exited in April will need to re-enter to be eligible
 to collect jobless benefits.
 
 As a result, the May jobless rate could spike 10 percentage points to 25% reflecting a surge in re-entrants and new job losers. How many companies have ever stress-tested for 25% unemployment? With record-high joblessness, what's
 the new normal level of consumer demand for vehicles, travel, smartphones, etc? Investors need to rethink company sales and profits expectations based on a much lower level of consumer sales.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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In April, federal withheld income tax collections posted a record drop from year-ago levels. The scale of the decline indicates that the reported figures on job loss and unemployment are understating the collapse in labor markets. How [...]

Uh-Oh!: Record Drop in Taxes Signal Deep Consumer Recession

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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

Heavy US manufacturing states underperforming while Sun Belt states outperforming

Rising long-term yields a global phenomenon

US financial market concerns shifting from growth to inflation

Economic activity is picking up in the US but remains lackluster abroad

Policy uncertainty has surged since the US national elections.

Recent turnaround in US economic surprises leading to increases in rate-cut expectations

The outlook has brightened in the US, while it has dimmed for other major economies

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

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With price stability as a key mandate, the Federal Reserve bears a significant responsibility to guarantee that the targeted price statistics accurately reflect people's experiences and are not influenced by political or statistical manipulation. However, the Fed's price targeting regime has become misleading and unbalanced since the price measure it targets has become less relevant to "actual" inflation. The Fed nowadays lacks a "Greenspan," or an individual who is both an expert in economic statistics and methodology and possesses the political power and influence to challenge the accuracy of published statistics or request their review. The matter of accurate price measurement is not just academic; it has real economic and financial effects.

Years ago, the Price Statistic Review Committee (PSRC), a group of academics, economists and statisticians, stated that, “If a satisfactory rent index for units comparable to those that are owner-occupied can be developed" then the committee recommends that BLS to use this approach for house prices and related expenses.

The General Accounting Office (GAO), which released a comprehensive report on how housing costs are measured in inflation metrics, made a similar suggestion. The GAO stated, "Most owner-occupied housing units differ significantly from many rental units. To apply rental equivalence in the CPI, a sufficient number of rental units must be identified that are comparable to owner-occupied units in terms of size, location, and quality, allowing the BLS to create a sample that accurately reflects owner-occupied houses."

In 1983, based on recommendations from the PSRC, GAO and others, the Bureau of Labor Statistics introduced the owners' rental equivalence method to estimate housing costs of owner-occupied homes. This estimation procedure continued until 1998, when the BLS announced that it had to discontinue the owner-sample due to an insufficient sample of owner-housing units. Moving forward, they decided to link the rent estimates for owners' rent to the other rent series. Neither the PSRC nor the GAO provided any comments.

The owners-occupied rent series constitutes roughly fifteen percent of the Fed's preferred price target, the personal consumption expenditure deflator (PCE). Combined with the thirty percent of the PCE that individuals do not buy, nearly half of the PCE deflator reflects an inflation rate derived from administered and non-market prices or imputations. How can this be regarded as a reliable or accurate measure of actual inflation people experience?

Price data should represent "actual" inflation, not a statistical distortion. Considering its essential role in shaping both monetary and fiscal policy, it is crucial for the price data to be accurate, relevant, and objective. The general public benefits from "actual" sustainable low inflation. But who gains when inflation might be understated, or its cyclical fluctuations are dampened or eliminated due to a new statistical method?

Over the past sixteen years, from 1998 to 2024, the average S&P 500 P/E ratio was 26.7. In contrast, during the preceding fifteen years, from 1983 to 1998, it averaged 15. Is this just a coincidence, or could the alteration in inflation estimation for housing costs, combined with the Fed's emphasis on an inflation measure representing only half of the actual inflation rate experienced by people, partly explain this shift? This misleading measure of inflation and policy approach has led to maintaining official rates lower than they might have been otherwise, which benefit finance, especially equity investments.

According to history, "Washington" is unlikely to change it frameworks (price and policy) unless another crisis occurs. The financial press could increase public awareness of this issue, but it has not done so yet. As long as the existing price and policy frameworks remain in place, finance benefits while "Joe Six Pack" loses ground to "actual" inflation.

The Fed Must Target "Actual" Inflation

Mickey D. Levy

The persistently stronger growth of the U.S. economy relative to most other advanced nations has been the driving factor that has resulted in a stronger stock market with higher valuations, higher interest rates and a strong US dollar.  A handful of charts highlight the sizable differences in economic and financial market performance across nations.  Nothing is permanent, and things—particularly shifts in economic policies--can initiate sizable changes in trends.  As we assess shifts in economic policies and central bank monetary policies, it’s important to keep in mind the economic fundamentals that drive financial markets.

**Real growth comparisons**.  Chart 1 shows the cumulative percent change in real GDP since 2000 in the U.S., UK, Europe and Japan.  In general, the faster growth in the U.S. reflects a combination of healthier gains in labor force and productivity.  Real GDP growth in the UK matched the U.S.’s pace from 2000-2008, while Europe nearly kept pace, benefiting from the boom in global trade fueled by the China super-cycle.  While the decade following the Great Financial Crisis was lackluster in the U.S., it was markedly slower elsewhere, particularly in Europe, which was hampered with ongoing financial crises during 2010-2014.

Chart 2 shows the same data but indexes real GDP to 2019Q4, which highlights the U.S.’s continued healthy growth following the pandemic-related contraction in the first half of 2020, while growth in Japan, the UK and Europe has been particularly weak.  The persistent outperformance of the U.S. economy is sizable.

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The GDP comparison between the U.S. and Canada tells a different story, as shown in Chart 3.  Unlike other advanced nations, Canada’s economy kept pace with the U.S. in the early 2000s, benefiting from its strong growth in its labor force fueled by immigration and the high demand for its exports of natural resources.  Following the GFC, growth in Canada outpaced the U.S’s soft recovery.  Canada’s growth slowed beginning in 2015 with the decline in oil prices and its shift in economic policies that focused on redistribution and social issues and deterred business expansion and economic growth. Canada’s economy has stumbled markedly in the 2020s. To highlight Canada’s weakness and lack of confidence, its business investment as a percent of GDP drifted down prior to the pandemic, plummeted in 2020, and has failed to recover, as shown in Chart 4.

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Calculations of productivity vary for different nations and are not directly comparable. However, the U.S.’s pace of technological innovation and the implementation of new innovations into commerce and society seems significantly more pronounced than in other advanced nations.  These growth and wealth-enhancing characteristics in the U.S. are facilitated and fueled by the structure of its capital markets, along with its higher degree of risk-taking and entrepreneurial spirit. These characteristics in the U.S. attract global innovators and risk-takers. Various nations are encouraging and rewarding innovation and facilitating advances in capital markets, a distinct positive for global grow.  However, at this point, a comparison of pro-growth characteristics in the U.S. and Europe, and Europe’s diminished potential growth, is striking. Note that amid the political turmoil in Europe, its leaders are discussing just about everything except policies that would promote sustainable economic growth.

Labor and employment data are similarly difficult to compare across nations.  The U.S.’s labor force has continued to grow and is very flexible, with significantly higher mobility than in other nations. The U.S.’s policies that influence the supply and demand for labor leave much room for improvement, but in general facilitate labor mobility much more than other nations.  This enhances the efficiency of business production.  The U.S. has also benefited from immigration, and except for Canada, is seemingly more adept than other nations at assimilating immigrants into the workforce and society.  Of note, while Japan now welcomes a large and growing number of foreigners into its workforce that offset the impact of its declining population, many nations in Europe, particularly Germany, have policies that constrain the mobility of labor and reduce economic efficiencies.

**Stock market comparisons**. Charts 5 and 6 show comparisons of the cumulative appreciation of stock markets.  Of note, Chart 5 measures the cumulative percent changes in the stock market indexes since 2000 in local currencies, while Chart 6 measures the percent changes in total stock market returns including dividends, in US$ terms.  Thus, the recent strength in the US dollar compounds the comparative U.S. advantage.

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The outperformance of the U.S. stock market reflects a combination of healthy economic growth, strong profits, growth leaders and high valuations based on favorable expectations.  The higher returns on the U.S. stock market generate expectations that the relative advantage will continue.  In the last decade, the U.S. has benefited significantly from new growth leaders that garner high multiples.  Those stock market leaders have also been the critical drivers of U.S. business investment and growth of the economy.  Certainly, there are periods when other nations’ stock markets outperform, but history shows that those periods are temporary.  Valuations and P/E multiples are higher in U.S. stock markets that in other markets, reflecting favorable expectations of future economic and profit growth.

**Interest rate comparisons.** The U.S.’s economic growth and productivity gains raise expected rates of return on capital, which lifts real interest rates.  Following the sustained period of low real rates that accompanied the GFC and subsequent decade of weak growth, real rates have normalized.  They are now similar to (but still below) the high real interest rates that accompanied the strong productivity-driven growth of the second half of the 1990s.  Except for Japan, inflation in all advanced nations has receded, and central banks have raised their policy interest rates above inflation.  The Bank of Japan is now normalizing interest rates as it strives to lift inflationary expectations to 2%. Bond yields have risen in all advanced nations and except in Japan, exceed inflationary expectations. Charts 7 and 8 show an international comparison of central bank policy rates and bond yields.

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**Exchange rates.** In an international context, capital tends to flow to the highest risk-adjusted expected rate of return.  Accordingly, the higher expected rates of return on US dollar-denominated assets are associated with a stronger US dollar.  Charts 9 and 10 show the trade-weighted dollar for advanced foreign economies and the dollar versus the yen and the Euro. The trade-weighted dollar is at high levels similar to levels of the late 1990s and early 2000s before it depreciated significantly and near all-time highs versus the yen.

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It is always important to assess how economic policies in the U.S. and globally influence economic and financial market performance.  Currently, the potential for shifts in policies is high.

Advantage U.S.:  Its Economy, Stock Market, Interest Rates and the Dollar

Has the traditional business cycle become obsolete? Not entirely, but major substantial changes in monetary policies and in the methods for calculating price measurement statistics, have altered the manner in which business cycles end. Business cycles consist of two components: an economic cycle and a financial cycle. Changes in policy and price measurement have shifted the pressures and excesses of the business cycle from the economy to the financial sector. In other words, high P/E ratios have taken the place of high CPI figures.

What Causes the Ups and Downs of a Business Cycles?

Some analysts and academics argue that the traditional business cycle characterized by increasing inflation and interest rates that eventually leads to an end of the cycle no longer exists. This perspective is somewhat supported when comparing business cycles before 1990 with those after.

For instance, since 1990, every business cycle has concluded with relatively low headline and core inflation. In contrast, from 1960 to 1990, business cycles ended with inflation rates of at least 5%, sometimes reaching double digits, with official rates significantly exceeding reported inflation.

However, to assess whether the traditional business cycle is now obsolete, it is crucial to first ascertain if the expansion and recession phases are influenced by government fiscal and monetary policies, developments in financial markets, or an exogenous shock. (Note: The business cycle that ended in 2020 was initiated by an unforeseen event, the pandemic, unlike the recessions of 2000 and 2007. However, in all three instances, both headline and core inflation were relatively low).

Essentially, significant technological advancements and globalization from the mid-1990s and beyond have decreased business cycle volatility, limiting or postponing price pressures that previously would have arisen during a typical business cycle. However, there are other factors at work as well.

During the mid-1990s, the approach to conducting monetary policy shifted from focusing on money and credit growth to targeting real interest rates. Most financial market analysts, myself included, did not initially see this shift in monetary policy as a major transformation. However, it turned into one when the BLS altered its method of measuring consumer prices in 1998.

In the late 1990s, the BLS stopped surveying the owner-occupied housing market to estimate owners' equivalent rent and began using data from the primary rental market, despite the fact that these two housing markets are influenced by different factors and frequently exhibit significantly different supply and demand patterns. At the same time, non-housing financing costs were removed from the CPI, continuing the previous exclusion of housing financing costs in the 1980s.

At that time, participants in the financial market did not consider these changes in price measurement to be significant. However, they were extremely important. During the housing bubble of the early 2000s, while housing prices experienced double-digit increases, the CPI indicated housing cost increases of only 2% to 4%. If the BLS had not implemented the measurement changes in the late 1990s, reported inflation would have been easily double what was reported.

(Note: The BLS excluded housing prices from the CPI in 1983, but continued to survey owner-occupied housing to estimate the implied rent for homeowners, maintaining a direct connection between housing inflation and increases in owners' rent. This connection was severed with the measurement changes in 1998).

The removal of non-mortgage interest costs also had a big impact on reported inflation. A joint research project by economists from Harvard and MIT found that the CPI from 2021 to 2023 would have been twice as high if consumer financing costs for were still included in price measurement.

Still, altering the methods for measuring prices had notable economic and financial impacts. Indeed, the revised CPI measure exhibits significantly less cyclicality, leading the Fed to aim for lower nominal and real interest rates than it would have if the BLS had not made these adjustments. This has led to considerably higher P/E ratios since 2000.

Economic downturns can stem from asset markets, as shown by the stock market crashes in 2000 and 2007, followed by recessions. The S&P 500 is trading at 22 times the projected earnings for 2025, and even higher compared to free cash flow projections. Other market indicators, such as the price-to-sales ratio, are also exceptionally high.

Therefore, the equity market is susceptible, particularly to an additional increase in market interest rates. Historically, the risk of recession increases when the yield on the 10-year Treasury surpasses the growth in Nominal GDP. According to current figures, there is merely a positive spread of 20 basis points with GDP outpacing the yield on the 10-year Treasury. However, current yields might still be too high given the lofty levels of the equity market.

However, the primary threat to the equity market and the economy lies in the fiscal strategies of the new administration. With the existing budget approaching $2 trillion, it is not financially viable to make the 2017 tax cuts permanent, as they are estimated to cost $4 trillion over the next decade, along with introducing further federal tax cuts. Even if the new Administration succeeds in reducing federal spending, it will not be significant enough to offset both past and new tax cuts, resulting in a budget deficit as large or larger than the current one.

More than three decades ago, President Bill Clinton shifted from his new economic agenda, which featured a middle-class tax cut, to a deficit-reduction strategy in response to the threat of increasing interest rates. At that time, the US was dealing with projected budget deficits ranging from $300 to $400 billion, compared to today's deficits exceeding $2 trillion.

Should the Trump economic team ignore the lessons from 2000, 2007, or even 1993, there is a genuine risk of a significant increase in interest rates. Market interest rates have previously impacted the fiscal strategies of a new president, and they have the potential to do so again, if not, the risk of financial chaos will increase.