Here’s one more reason to be worried about the economy’s prospects: subprime borrowers are having an increasingly tough time making good on their loan payments. And this even before the hostilities with Iran. As of February, more than 10% of the debt outstanding to borrowers with a credit score below 660 at origination was delinquent. This is the highest delinquency rate in more than a decade, and the direction of travel is disconcerting. I’m not particularly worried about what this means for the financial system, as there is much less subprime debt outstanding than in times past. Prior to the Global Financial Crisis, $3.5 trillion in subprime debt was outstanding, about 30% of total debt. There is now $2.7 trillion in subprime debt, which is only 15% of total outstanding debt.

Financial markets feel increasingly fraught to me, with the elements for a meaningful selloff coming into place. This threat is highest for stocks and corporate bonds, but even crypto, gold, and silver remain at risk despite recent pullbacks. Valuations are high. There are good fundamental reasons for this, but markets appear increasingly tainted by speculation. That is, investors are simply investing on the faith that prices will rise quickly in the future because they have in the recent past. On the fundamentals, the economy’s performance is mixed. Real GDP is the strongest indicator, and it is growing just over 2%, below the economy’s potential, estimated to be near 2.5%. Employment has flat-lined, and unemployment continues to creep higher. Inflation, as measured by the Fed’s preferred consumer expenditure deflator, remains stubbornly and uncomfortably high at 3%. And there is no economic upside to the renewed chaos over tariffs and a looming military conflict with Iran.

My previous post argued that the economy is on the precipice of recession. How will we know if we are in one? Historically, it's not clear-cut until well after the fact. The pandemic was one time that it was. Even then, there were deniers claiming that the recession calls were politically motivated. A group of academics at the NBER is the arbiter of when recessions begin and end. While they look at a plethora of data to make this determination, most importantly, far and away, is payroll employment. If employment declines for more than a month consecutively, we are in a downturn.

Global investors anticipate two rate cuts from the Fed this year and more next year. This is a reasonable forecast and consistent with my baseline, but I don’t hold it with any confidence. It is increasingly likely the Fed will sit on its hands and not change monetary policy in 2025. Given the mounting tariffs, inflation, which is already meaningfully above the Fed’s 2% target, will significantly accelerate. The core consumer expenditure deflator is up 2.8% over the year through June, and given the tariffs will be closer to 4% by next spring.

A ton of economic data comes out this week, and the storyline will be that growth has slowed sharply so far this year. GDP will grow 2.8% in the 2nd quarter, but this is a tariff-induced bounce from the 0.5% decline in the 1st. First-half growth will be less than half of last year’s nearly 3% gain. Cautious consumers are largely behind the slowdown. Real consumer spending has gone nowhere since the end of last year, and with the release of the June data this week, we will see that consumers are still on the sidelines. And this is before the tariff-related price increases kick into full swing.

I sent off a yellow flare on the housing market in a post a couple of weeks ago, but I now think a red flare is more appropriate. Home sales, homebuilding, and even house prices are set to slump unless mortgage rates decline materially from their current near 7% soon. That, however, seems unlikely. Home sales are already uber depressed, but homebuilders providing rate buydowns had been propping sales up. They are giving up. It’s simply too expensive. A big tell is that many builders are delaying their land purchases from the land banks. New home sales, starts, and completions will soon fall.

Fannie Mae & Freddie Mac’s fate is back under debate, 15 years after entering conservatorship. Their stock prices are up, but what’s next for the GSEs? Here’s a breakdown of the most likely scenarios over the next few years, their probabilities, and their impact on mortgage rates: Scenario 1 - Status Quo (50%): GSEs remain in conservatorship. Mortgage rates won’t change. The system works well as-is, with risks already shifted to private investors via credit risk transfers. No legislation is needed, and there’s little incentive to disrupt what’s already functioning smoothly.

The Trump administration’s policies are set to severely diminish the economy, not only for the next few months but for years. The administration’s trade war is undermining the global safe-haven status of the U.S., which has provided incalculable benefits, including our economy’s exceptionalism. Safe-haven status means that global investors know that if they invest in the U.S., in a Treasury bond or anything else, their investments’ value won’t be upended by a capricious government; laws and regulations are transparent, and while they may change, only after deliberation and due process.

The runup in stock and house prices since the pandemic is eye-popping. Stocks are up 60% and homes 50%. Household net worth has swelled by $300k per household. While only 2/3 of households are benefiting, this is big money and a big part of the U.S. economy’s current success. The record stock and house prices reflect the strong economy and in turn power it. This works through the so-called wealth effect – wealthier households are able and willing to save less and spend more. Indeed, stalwart consumer spending has driven the economy’s growth.

You’re no doubt aware that the Moody’s Analytics’ Presidential election model predicts that Biden will be re-elected. While based on a bunch of assumptions such as voter turnout and the popularity of 3rd parties and the economy’s performance, I’m confident in the result. But… …having said this, based on the modeling, it is clear the election will be close and hinge on a few key factors. If 3rd party candidates catch on at all, they will swing the election to Trump. If gas prices rise to near $4/gallon, from closer to $3 currently, Biden will lose.

Not only did the economy avoid recession in 2023, as widely feared, the economy had a stellar year. The latest evidence is the just released Moody’s repeat sales house price index for December. Prices are up 5% from a year ago and almost 50% since just prior to the pandemic. House prices are off from their all-time highs in and around Texas and the Pacific Northwest, but only modestly, and they continue to push higher in the Northeast, and industrial Midwest and Southeast. In Philly, my hometown, house prices are up 7% from a year ago.

It’s conventional wisdom that most Americans believe the economy is performing badly. But do they? Color me skeptical. Most analysis that comes to this conclusion rests on the University of Michigan consumer sentiment survey, which is VERY weak. But this survey is flawed. UMich is a survey of 600 people who are asked their political party affiliation. Once asked this, all other Qs are answered through this prism. As such, Rs believe the economy is cratering - worse than in the worst of the financial crisis or the pandemic shutdowns. Huh?

As 2023 comes to an end, it is increasingly clear that not only did the economy avoid a widely anticipated recession, but it was also a great year for the economy. Real GDP is on track to grow a heady 2.5%, unemployment has remained below 4%, and inflation has quickly receded. Most encouraging is the revival of the supply-side of the economy. Productivity growth has rebounded, and the labor force is surging due to more participation and immigration. That’s how the economy has been able to grow so strongly with such low unemployment and less inflation.

Handwringing over the increase in household debt and delinquency has been loud. The worry is that consumers are stretched, will soon stop spending and recession will ensue. This worry is way overdone, as inflation recedes so has borrowing, and delinquency will follow next year. Credit cards, consumer finance loans, and auto loans did take off after the pandemic shutdowns ended. This reflected the higher inflation, as we had to spend more to buy the same stuff, and as the higher prices cut into the purchasing power of particularly low-income households.

The economy is hanging tough in part because of the graceful adjustment of asset prices to Fed tightening. While overvalued stock, bond and real estate markets have bent, they have not broken. Americans remain wealthier than before the pandemic, and key to why they keep spending. Housing is the poster child, despite surging mortgage rates, prices nationwide have simply gone sideways since peaking in summer 2022. Prices are still up a stunning 40% since the pandemic hit. Thank the severe affordable housing shortage for propping up prices.

The economy is meaningfully less interest rate sensitive than in times past. The tweet thread that follows lays out the case why, but this is a big reason why the economy has avoided recession despite the Federal Reserve’s aggressive rate hikes. Using some jargon, r* has risen. A big reason for the economy’s increasing rate insensitivity is that households have admirably locked in the previously record low rates. Only 10% of household debts have rates that adjust within one-year of a change in market rates. That’s down from 35% in the early 1980s.

Contrary to the fears of many, inflation can recede without a recession or anything close. That’s the overarching message in the GDP report for the 3rd quarter released last week. Real GDP grew by a hot 4.9% but the core consumer expenditure deflator increased by a cool 2.4%. Behind the stellar report is the fading economic fallout from the pandemic and Russian war. These massive global supply shocks hammered growth and fanned inflation, and while they continue to reverberate (e.g. sky-high new vehicle prices), they should settle in coming months.

If you had told me a few months ago that today 10-year Treasury yields would be near 5% and mortgage rates over 8%, I probably would have told you that the stock market would be down big and the economy headed to recession. While that still could happen, odds are good that it won’t. That’s because the surge in rates hasn’t been fueled by high inflation or rising inflation expectations, which is what I would have likely assumed in that hypothetical. If so, the Fed would still be tightening policy, and that would be a mortal threat to stocks and the economy.

As a professional economist, I do lots of forecasting. Some forecasts I’m confident in, some not so much. I’m confident that the growth in consumer prices for shelter is headed much lower and that this will push overall inflation back near the Fed’s target by this time next year. My confidence rests on market rents, which have gone flat over the past year. This will weigh on the growth in the shelter CPI in the coming year, given that the BLS uses market rents in its construction of the CPI, and that it takes about a year for rental leases to roll over.

The August jobs report was packed with good economic news. Especially good was the boomy growth in labor supply. Underlying labor force growth - abstracting from the vagaries of the monthly data - is a strong near 250k per month. More supply supports more jobs without inflation. The report makes clear that the economy is not at full employment. How could it be with participation still rising and so many people coming into the workforce? The report also makes clear that the economy can support lots of job growth without fanning wages and inflation.

What recession? The consensus view that recession was virtually a slam dunk looks increasingly off base. Yes, there will eventually be one, but odds that a downturn is dead ahead are receding. There are a bunch of reasons why the economy is hanging tough. Here are my top three… First, excess savings. Consumers couldn’t spend as they typically do during the pandemic as they were stuck at home. At the peak, excess savings amounted to 10% of GDP. Consumers have since been using the savings to supplement their purchasing power and calibrate their spending.