Transcription
I'm in the Chris Waller camp. I don't have a big inflation view for you. I don't think that tariffs, I look at tariffs, are like a form of taxation. They're not a form of sustainable inflation. It's not as if we're seeing a boom in the money supply. And then you could say, well, are we getting a monetary shock? The tariffs are not an inflationary shock. I think they'll probably be more of a shock on profit margins than a squeeze on real personal incomes.
As far as the recession is concerned, I think those pressures are still building. And actually, if you look at the data to the first half of the year, what saved the economy from actually having negative real GDP for both Q1 and Q2 was this AI spending boom that is ongoing, showing no signs of stopping. That is fortuitous because without that business investment, the rest of the economy is so weak that we probably would be in a recession right now.
Well, I don't really know where the resilient consumer narrative is coming from. I think it's because a lot of people are still looking at the economy through the lens of a rearview mirror. I mean, real consumer spending, if you take the first quarter and second quarter together, was barely more than a 1% annual rate. We've hardly ever in the past, in the context of an expanding economy, had the consumer, which normally is running between 3 and 4%, running barely above 1% on a 6-month basis. So I don't think that the consumer is leading the charge here. The consumer is actually sputtering. And if you're looking at the buying intentions components of the University of Michigan, and this is an August number, you look at auto buying intentions, home buying plans, intentions to buy big ticket durable goods, they all rolled over rather significantly in the past month.
You're not seeing any impetus from exports. You know, we got the advanced international trade numbers today for the US for July. Exports are down four months in a row. So, I'm not seeing vitality in the consumer. I don't know where that view is coming from. We're not getting vitality from the export sector, which actually has pretty powerful domestic multiplier effects. The housing industry, notwithstanding what the home building stocks have been doing, the housing industry is still in a state of morass. And the only vitality and vibrancy I see is on the data center spending boom that we're seeing. That's really the only thing right now holding the glue together.
It's a shame that you have so many people saying, "Well, core inflation is is closer to 3% than 2%, that it's too far above target." Inflation is a lagging indicator. Why is everybody so consumed with the lagging indicator? It's not where inflation is now. It's not about where core inflation is now. It's where is it going to be in the next 12 months and where's it going to be in the next 24 months. Because you could have sat there in the summer of 2008 when oil was pressing against $150 a barrel and inflation is running close to 5%. And you could have said the Fed's got to be insane to cut rates. Well, look what happened.
No, I'm not saying we're going to slip into some financial crisis. However, inflation is a lagging indicator. And when I'm taking a look at the contours of supply and demand in the economy, what I see are disinflationary forces building. And I'll tell you, it's funny that nobody talks about what's happening in the housing market. We just got the Case-Shiller numbers and showed that home prices in the United States are down four consecutive months. That is a pattern in the bedrock of the household balance sheet and just about the biggest asset on commercial bank balance sheets. So, I have never seen a cycle of real estate deflation. And this is just starting because take a look at the inventory numbers. We flipped this market in the past 12 months from what was a seller's market to a buyer's market. And the inventory numbers are going up dramatically. When you're taking a look at the available supply of units for sale in the existing housing market and the new housing market, you benchmark that against where demand is. The inventory levels are going to continue to swell. That's going to put downward pressure on home prices. And as I said in 2006 and 2007 when nobody listened to me, real estate deflation cycles never end well. And this was starting before the S&P 500 peaked in October of 2007, 'cause people say, "Well, look at the equity market." Okay, yeah, but the housing market is actually more important and it is starting to deflate.
So, I think that Chris Waller is 100% right. I don't remember that in a speech that he gave in Miami on Thursday night that he talked too much about housing, but he talked a lot about the labor market and the labor market is cooling off quite dramatically. And it's not just about the dual mandate. It's about how are you going to get inflation if you don't get whatever cost increases you see from tariffs. If it doesn't get passed into wages, there's no inflation. That's where a lot of us got it wrong with transitory 2022, 2023. Although maybe 18 months was transitory in the overall analysis of economic and financial history. It was in the 1970s. But you see, we went from basically zero inflation to call it 9% inflation. And the reason that happened was because we had a super duper tight labor market. And the shocks we were seeing, of course, never mind Big Beautiful Bill. That's not that significant in terms of adding to economic growth compared to the stimulus checks that were being mailed out in 2020, 2021, which was a gift that kept on giving. There was tremendous fiscal stimulus, cash stimulus checks at a time when the economy was reopening, but supply chains were still being squeezed because it was happening in China. So, we had that inflation push. What made it worse, though, was that it went into wages. But, this is a totally different labor market right now. So, I think they should have cut rates in the summer. Most people don't agree with me. Getting to neutral means getting down to 3%, which means they have about 150 basis points to go just to get to neutral.
And although I don't like the way that President Trump's been going about bashing the Fed, it has been perplexing to me that the Fed cut rates last fall. I mean, that first rate cut was almost a year ago and then they go on pause because of tariffs and all Powell talked about was how tariffs are injecting all this uncertainty. Well, uncertainty is not inflationary. Uncertainty is disinflationary because you stop spending. And like I said before, if Thank God for Nvidia, thank God for ChatGPT. If it was not for this AI boom, the economy would be contracting right now. It is perplexing and I share in some ways Donald Trump's frustration that the Fed went on hold for the past, call it 9 months, with the same sort of economy that we had when they were cutting rates. And I'm certainly not saying we got to go down to zero or even go down to 2%. But to get to neutral is to me is a no-brainer. They should be there right now. To tell me, well, how can they go to neutral when core inflation is closer to three than two? I don't care because it's not where inflation is now. It's where it's going to be. And this is where I think the Fed is going to get into trouble 'cause all you hear about is data dependency. No, a central bank can't be data dependent because their actions affect the economy in both directions with lags. You have to be forecast dependent. And I'll tell you, even before Jackson Hole, when you go back to the last set of FOMC minutes, what did the Fed staff do? All the FOMC participants, all the policy makers are just baffle gabbing. That's what they do. You go back and read the transcripts, these guys just talk. The only entity at the FOMC meetings that has a model and provides a forecast are the Fed staffers. They actually cut their inflation forecast. What's more important to you? The July PCE deflator or the Fed staff model for all its warts and pimples and scars telling you that they're reducing their inflation projection? That was important for me. Not just that, the natural rate of unemployment. They said it's going to continue to go above next year and the year after that. So as you get this gap between the unemployment rate and where the equilibrium unemployment rate is, you build up excess capacity in the most important market of all, which you can't trade, but it affects everything, which is the labor market. You're not going to get inflation. You know what you're going to get when you build up slack in the labor market with a cost shock from tariffs. You get a profit margin squeeze. And believe that is nowhere near priced into this broadening equity market rally we have in our hands today, which is a lot of speculation, a lot of momentum, a lot of leverage, not a whole lot of fundamentals though.
And nobody, I said before, you know, it's funny, nobody talks about Canada's loss of tax competitiveness. We're just anally focused on trade and tariffs. And nobody talks about the disinflationary forces coming out of the US housing market and coming out of the labor market. People just talk about the stock market, but what they haven't seen yet is the margin squeeze. People are consumed with the inflation fear, which means that if there's the inflation, it means that those costs are going to get passed on to the consumer. But as the unemployment rate goes up and then nominal wage rates go down, that's economics 101. Real personal incomes contract and there will be no final inflation. We will just be left with contracting real incomes and a margin squeeze that's not priced into the S&P 500 right now.
I think that in the Canadian context, there's some interesting things happening at the political level. You had this phone call between Mark Carney and Donald Trump. Next thing you know, Canada is backtracking an array of countervailing tariffs that we had on the US, you know, in conjunction with what's duty-free in the USMCA. So, there's something happening behind the scenes between Canada and the US right now. And it may well be that we're on our way towards something that's a lot less sinister than what we had in our hands a few months ago. And it'll give companies maybe a little bit more visibility.
The one thing that's very interesting, you mentioned the negative GDP quarter for Q2. And you look at the monthly number and Statscan's estimate for July, there's almost no growth heading into the third quarter. But yet, the bank CEOs seemed pretty cheery over the course of the past week after they released their numbers. And of course, talking about release, also releasing their loan loss reserve provisioning. So they're seeing something, I guess, that's a little more bullish than what I am, at least on the consumer spending outlook or the consumer finance outlook. But I would say that the Canadian economy was weak when the US economy was strong. You know, we're still beset here by a variety of structural factors. But I'm getting a sense that there might be more room for optimism now that Donald Trump has got a lot of these so-called deals out of the way with his international partners. You could spend more time focusing on Canada. And I think that there's no longer the elbows going up. Right now we're talking about stick handling with the puck. So that might be some verbiage that maybe some of these uncertainty clouds as far as Canadian business is concerned, dealing with the uncertainty. Maybe that's going to part. We may find in the next few weeks that there might be some big announcement between Canada and the United States that could be rather beneficial.