In this episode, you'll see why we think manufacturing and productivity are beginning to boom and why employment is going to increase much more than expected as inflation drops dramatically.
Greetings everyone. This is not the usual setup because I'm in Southern California for my niece's wedding, the first wedding among my siblings. So really excited about the family reunion. And so this is a little bit of a different setup and maybe a little bit of a shortened take. Instead of introductory comments, I think we're just going to go right into charts. I guess I'll summarize the charts by saying with the employment report today, it is employment Friday. We got all kinds of signals, something for everyone. For example, non-farm payroll employment at 117,000 increase, that was much higher than the 70,000 to 75,000 increase expected. However, the household employment, which captures more small businesses, fell. I think it's fallen for the last three months and it fell by more than 200,000.
Another thing that we learned is that the average work week expanded. So that's good news, because maybe instead of hiring people, companies are asking current employees to work a little longer. So that suggests strength in the economy. On the other hand, we saw wage growth up only 0.2%. So that's 2.5% roughly annualized. At the same time, productivity is roughly 3%. So we'll get into some of that. So again, something for everyone. I would say peeling the onion a little bit more. Manufacturing is beginning to take off. Services are disappointing a bit. Services are much bigger than manufacturing, but typically when manufacturing takes off, services will follow. So that's good news. So as usual we'll go through fiscal policy, monetary policy, economic indicators, market indicators and we also will weave in some Kalshi charts.
As I mentioned last month, we are partnering with Kalshi to provide them with a series of markets effectively based on questions that we are providing. These are some of the macro questions. We're also putting in innovation related questions, lots of them in the multiomics or life science space. Some of which are gaining traction. And one of the things we're excited about in terms of Kalshi is we really do believe that this is going to create a shift back towards truly active equity management. Why? Because at least in the stock related or innovation related questions, we're focusing on the variables that we think are most important to whatever company we are providing the question for. And so if more and more people focus on these variables, the most relevant variables we think, we will start to have something to fight sort of the algorithmic trading that has really taken the market by storm and the high frequency trading that dominates trading all day. So early days, we're very excited about this partnership and so let's start with the first one of these charts just to give you a sense on the macro side.
So here is, and we're learning lessons too. This is early days. So the way I originally had phrased this question was will the US federal deficit to GDP ratio drop below 5%. And what that means is improve relative to 5%. So, we're looking for the deficit, which is a negative, to go to 4% and 3%. And of course, Treasury Secretary Bessent's goal for the end of 28 is 3%. So, an improvement in the deficit. Now, here it says for fiscal year 2026. What I meant, and clearly we're learning, is in any month in fiscal 26. So the fiscal year ends in September. And I'll show you where we are right now. So you can see the deficit has been improving. It is at minus 5.2. And the spirit of the question is will it move up to minus 4 anything before the end of September? We believe the answer is yes. But the way the question is phrased on Kalshi, it is highly unlikely that we will see that on average for the fiscal year because we'd almost have to go, well we'd have to see dramatic improvements from here to get, really it looks like we'd have to get dramatic improvements before the end of September. I don't think we will. But I do think this will cross above the minus 5% line despite the fact that federal corporate income taxes have come down so dramatically.
Now many times when you see corporate taxes come down like this we are in a recession. You can see the shaded areas here are recessions. But this time around it is because corporations are enjoying accelerated depreciation and are getting huge refunds because if they put a manufacturing facility in service anytime this fiscal year, or this calendar year and last calendar year because this was retroactive to inauguration day last year. So if a company put a facility into or started running the facility, then it would be allowed to use accelerated depreciation so that instead of depreciating over 30 or 40 years it could depreciate in one year. So, what you're seeing here are huge refunds to companies, and yet the deficit has been improving. Isn't that interesting? That tells you that the economy is probably stronger than many of the headline reports we see. And here you can see another reason that the deficit should be going up not down and it's the refunds for individuals. The refunds are up 17% year-over-year and that is of course because no taxes on tips on overtime and large parts of social security. So despite that the deficit has been going down. That's very interesting. It probably means the economy is stronger.
Now, one of the things we've been saying is that because of these tax changes, and because of deregulation, we believe the return on invested capital in the United States will increase relative to that in other countries around the world. And that usually means, well, that's usually dollar positive. That usually impacts the dollar positively. Now, the narrative out there has been stuck on deficits and debt and so forth. And as you may know, if you've been listening to In the Know, we believe we're going to grow our way not out of debt. We think we're going to grow our way out of deficits into surplus and then as that happens take down the debt. And so we do believe that that too will be dollar positive. So how high will the DXY, which is the trade weighted dollar, it's only six countries, get this year? Now right now, and I'll show you in a moment, it is in the 98 range and you can see the forecast here is 103.1. That's very interesting. Most, or as I mentioned the narrative has been that the dollar is going down because of deficits and debt. Now the Kalshi betting here is saying no it's going up. I don't know very many people except for ARK who think it's going up. So very interesting and here you can see where we are. Yes 98. A lot of people have been saying the dollar's crashing. And as I've shown this chart before, it's not crashing. It has been coming down. It is stabilizing. And we think the next big move is going to be to the upside. So if I put my cursor where Kalshi says it's going to be 103, we think that's very possible.
So now we'll move into monetary policy. Here you can see the CPI inflation rate versus M2 growth year-over-year. M2 in purple, CPI in green. And you can see, and M2 is pushed forward by 18 months because money growth tends to lead to inflation. And you can see that absolutely happened during COVID. The monetary policy went crazy. I think peak year-to-year growth was 27.5%. And inflation followed and on the CPI it peaked at 9% on true inflation it actually peaked at 11%. And then of course it did unwind, moved into negative territory which it needed to do and now we've had the cyclical rebound. So just looking back over time when has money growth been higher than the CPI and are there sustained periods where that is so and the answer is yes and it's usually in the early stages of a recovery and then expansion. You can see here in the 80s coming out of the back-to-back recessions in early 1980 we had money growth well above inflation. And then again you can see it before and after the tech and telecom bubble and bust again there it was well above and then you can see it after the 08-09 crisis. So here we are money above CPI but we haven't been through a recession or have we? As you know, we've been saying we had for three years, two and a half to three years, we have been in a rolling recession. Certainly, manufacturing has, housing has, low and middle income earners are feeling like we're going through something more than a recession. And so, I think, we're in the same kind of environment as we were post those recessions. It is when consumers are cautious and optimism is low. So that is where we are right now. So we don't think M2 growth which is at 4.9% is a harbinger of 5% inflation for example.
Here you can see monetary policy is it easy or tight, below zero. So this is the yield curve the two-year versus the three months. So this is a shorter term yield curve. You can see we were negative during those two and a half three years supporting this idea that the economy was in a rolling recession of sorts. And you can see we've just come out above that. The Fed has been easing for a while right now. You'd never know it from the narrative out there in the headlines. And yet it's this measure of the yield curve is just barely positive. You can see what happens during other recessions. It tends to move into you know the roughly the 100 basis point range or above. And right now we're only at 23 basis points. Longer term on this measure of the yield curve, the 10-year Treasury yield to the 2-year Treasury yield, we're above zero, so positively sloped. But look what is happening. This to me is fascinating. I know I'm a bit of a geek when it comes to economic statistics, but I've been struck that we've seen a downtrend in this measure of the yield curve since the global financial crisis. And as you can see in prior recoveries we got certainly post 1990 we got into the 250 to 300 basis point range. Right now we're only at 49 basis points and it looks like we might be rolling over again. What could this mean? And one of the reasons I was struck by this early on was wait a minute in COVID every country in the world was stimulating massively on both the fiscal and the monetary policy sides of the equation and look we only got to 150 basis points and I've been asking why would that have been and I think one of the reasons is that the long-term Treasury yield is beginning to hone in on deflationary undercurrents. And if it continues to move down now, we will have confirmation of that. And many times I've gone through the deflationary impact of all of the 15 technologies around which we have centered our research and investing and they're beginning to move the needle.
Now AI, every company's an AI company. They have to be just like every company's an internet company. In other words, they use these technology tools to increase productivity. And so AI training costs are dropping 75% per year and you've heard me before inference costs down 85 to 95% plus per year. Highly deflationary. Now why don't you hear a lot about that? It is because the frontier models are very expensive. The bleeding edge models, GPT 5.5 came out in the last 10 days and OpenAI has released something called o3 which can reason for 20 hours and just gobbling up tokens and performing better than Claude, Claude Code the latest version. So now you're seeing developers flock back to OpenAI and we see this competition actually accelerating the space. So those models are very expensive but if you are using one generation before those models your costs to do so are collapsing. Good enough. Most people and certainly we do, we want frontier, we're doing leading edge research so we're willing to pay but a lot of companies can't afford to pay that much so anyway highly deflationary for most of the world.
Here you can see what's also striking is that that yield curve is starting to compress even though oil prices on a three-month moving average basis are up 57% year-over-year. And normally if this kind of increase in the oil price has been monetized, the yield curve does not start to flatten out. It steepens. The fear is that the Fed will monetize if the pain gets, if the pain is too much. So that is not happening. That's really interesting. Same thing here. Commodity prices. Here's another way that you can see that and this is not just oil. This is lots of commodity prices are starting to move up because we are in the middle of, we believe, or in the early stages better said, of what we believe will turn out to be a manufacturing boom. So demand is increasing relative to supply and we'll show you some green shoots later on. And yet here again the yield curve as I just mentioned is flattening. So interesting.
Here you can see inflation itself as measured by the core CPI and the core PPI. And what you're seeing, interestingly, and it doesn't happen very often, is the producer price inflation in green on a year-over-year basis is above the consumer price inflation, which is in the purple. Now, when does this normally happen? Normally happens during recessions when the consumer says I can't pay. I'm not going to pay anymore. And as I said, we think this is a vestige of the rolling recession that we believe we're exiting now. But it does seem to corroborate that we have been in a painful environment and that consumers just are not willing to pay. So the consumer goods companies certainly and services companies are having to eat some of these input cost increases.
So and then here you can see this is a measure we haven't really shown it here before but it's very commonly used by the Fed, it's one of the metrics they monitor and I think Kevin Warsh even more so. This is looking forward five years what is the expectation for the five-year annualized rate of inflation going forward. And as you can see, despite all the headlines about inflation, it is below the average of the history of this chart, which goes back to 2000 and it has essentially been stuck in a range for the last three years. The latest tick up is related to oil prices to be sure. But we think this is going to reverse and you, well I'll get into why we think so in a minute. But here's another Kalshi question. Will core CPI inflation fall below 2.2% this year? And you can see that the odds here are very low according to the wisdom of crowds. Now we would disagree with this one. You can see where it is right now. It's at 2.6. It has been coming down. It has been coming down 2.6%. And this takes out food and energy. So energy, the direct increase in energy prices is not in here. The indirect impact of energy costs is in here to some extent but as I just mentioned consumers are saying we're not paying that. And so 2.6% is where we are. And again in the context of history and this goes back to the 70s. 70s were very inflationary, 80s 90s disinflationary to post global financial crisis you can see steady state around 2% and we're closing in on that. But most people in this survey do not believe we'll get below 2%. And I think this is in 26. Yes, in 26. We think we will get below 2%. And here's one of the reasons why. Trueflation. This is a measure of thousands of items, goods and services measured 24/7, so real time. And even with food and energy in the mix here, you can see we're at 2% already on this measure. And on the core measure, which is what this bet is all on, we're at 1%. We're at 1%. And you can see in this total trueflation, not the core, it went through the wrestling that we're still going through in the markets saying will inflation get back to 2% and stay there or not. So you've had a lot of uncertainty in the last three years. It has resolved to the downside. Oil is giving it a little bit of a challenge here but still we're only at 2%. Core we have broken down. This has resolved to the downside and you can see the only times we've seen this, we didn't, are right after COVID when the world shut down and everybody was scared we were in a global depression and in 2015 we're below there now but that's when we had a big China scare and of course this was European sovereign debt crisis and post global financial crisis as well, but even then it was on its way up. Today it's on its way down. Fascinating.
Now, here's another question. Non-farm productivity. Now, when we first put this together, we thought, as we examined the numbers more closely, quarter to quarter, we thought, oh my goodness, a year ago, first quarter, non-farm productivity was negative. I think it was a minus 0.9% quarter to quarter at an annual rate. And this last quarter we thought that productivity might get to a level quarter to quarter at an annual rate that when compared to a year ago would take us above 3% in the first quarter in any quarter in 2026 is the question. So here you can see this, we're kind of, we're at 49 so 50/50. I don't know. I thought it would have been higher because of the comparison to last year. But I don't think anyone was really doing the arithmetic that way. But here we are. Here's what happened in that comparison. It was up 0.8% in the first quarter. Now that's quarter to quarter at an annualized rate versus down 0.9% first quarter a year ago. So we almost got to that 2.9%. Not quite there. We'll see what happens with revisions. The year is not over with revisions and we think productivity will be revised up. If anything we think productivity is being understated and inflation overstated in the GDP and other accounts. So with a revision this actually could go above 3%. We shall see. However then that would be for the first quarter. Then we face in terms of year-ago comparisons four and 5% growth rates at an annual rate quarter to quarter, second quarter and third quarter. So it would probably be hard to sustain that 3%. So this is all going to come down to revisions we think.
So thanks to productivity going up, unit labor costs are going down. And I wish we had pulled this chart into the 70s you would have and it basically looks like that 7.5 to 10% and on an extended basis. But you can see as measured by unit labor costs inflation rate the inflation rate is very low 1.2%. It kind of corresponds to the trueflation core inflation rate. And so what this means, and this is really important, if we're right and productivity is roughly 3% now, we can have 5% compensation increases. So 5% year-over-year compensation increases minus the 3% productivity increases would give us 2% unit labor costs. So 2% is the inflation rate they're going for. We're below that now. And again, this convinces us that inflation is going to surprise on the high side of expectations.
Now the consumer is reacting to affordability and jobs. This one is jobs. So technically the labor differential is jobs easy to get minus jobs hard to get. It's a survey and you can see the labor market has been deteriorating since the Fed really started raising rates in 2022. So here you can see consumers are not feeling good about the job market at all. And so with Kalshi we've asked this question, will youth unemployment, and the cohort is the 16 to 24 year olds, will it fall below the unemployment rate fall below 7.5% this year? And again big no it won't. They're betting heavily against that. And the reason is we're hearing headlines or seeing headlines about entry-level jobs disappearing. So what's happening, the initial unemployment insurance claims are not going up they are going down actually surprisingly so. So companies are not firing although we do hear headlines. We're hearing a lot of technology companies laying off doing reductions in force and they're pretty large 10 15%. But the economy as a whole is not firing people any more than it usually does. All of this is seasonally adjusted, but they're not hiring as readily. They don't expect youth unemployment to fall below 7.5% this year. Only a 14% chance. So here you can see where it is. It is at 9.5%. It had been 8.5%. So it's popped up here. So the entry level jobs, yes, they're hard to get. You see the unemployment rate, however, is staying relatively low, 4.3%. Look at that in the context of history. Even the youth unemployment rate in the context of history is not that high. But I think AI is taking all the entry jobs headline is causing this Kalshi bet to be very low meaning only a 14% bet that it will go below 7.5. We have been looking at some charts from Indeed and what they're showing is broadly the number of new jobs is not rising that much but what they're showing for even software developers, so that's where a lot of layoffs are taking place, those jobs are going up, the job posts are going up in other words companies are looking for them. So that's very interesting because they had been coming down very very quickly. So we think that that is a harbinger for this unemployment rate. We've had the shakeout in terms of the developers. Claude Code and OpenAI's Codex are taking a lot of entry-level jobs, but the economy is starting to grow and grow more quickly than many people expect. So, we do expect this unemployment rate to drop back below 7.5%.
Here's another Kalshi market. Will the Michigan consumer sentiment index go back above 65 this year? And the answer is absolutely not. Only a 16% chance. Well, here is a picture of that sentiment index. It's near an all-time low. In fact, it just dropped to a new low. We just got the numbers today. Unemployment Friday. So the consumer is not happy and you can see here to get to 65 so going from here to here would be a leap but we do see step function moves all the time in this index. You can see during recessions you'll get a step function down and during recovery step function up. We think it could happen. There's a much higher probability. But you can see what happened with this last month. The oil prices going up the way they have really really hurting the affordability of the lower and middle income earners and even the high income earners. They ticked up the sentiment ticked up because the stock market's at an all-time high. But not very much, not a lot of happiness on that this chart, especially in the context of history here. And you can see the affordability index is eating into the personal saving rate down to 3.6%. So the saving rate will go down during rip roaring economies because consumers are willing to take more risks and you know basically take their safety net down a bit. That's not where we are right now. The saving rate is going down because oil prices are really squeezing budgets. And you can see the auto delinquency rate both for subprime and overall back up near 08-09 levels. They'll allow their cars to be repossessed. We think because now we have Uber and Lyft. We didn't have those back then. Here you can see consumption though and this is just a reality check. So this is real personal consumption growth. Very recently it's gone to roughly zero because of oil prices. This is year-over-year percent change based on a three-month moving average. It's okay. It's okay. So those higher income earners, they may not be feeling great, but they are spending some of their stock market gains.
Now on to green shoots. Green shoots in the economy. Manufacturing is stirring and you can see there's been a big move up here. And it's probably because manufacturers have taken inventories too low. You can see however that services are not doing as well. So you can see orders in the green there. They had been ticking up and just went down could be a reaction to oil prices and the prices paid here going up. So this makes sense. This makes sense. If prices are going up then demand will probably take a pause and we think that's what's happening now. You can see back on the manufacturing side, flat bed truck market demand more on the good side. There's been a big move up here corroborating this, you know, shipment of goods is taking off out there. Now here is housing. And you can see that pricing is falling. New home price appreciation is non-existent. Really the prices here have been falling for almost three years now and they've just taken a turn for the worse. So and even existing homes prices which are in the green here essentially no inflation and this is another reason we expect core inflation and overall inflation consumer price inflation to surprise on the low side of expectations in the next six to nine months. Here you can see that existing home sales, nope, relapse. The spring selling season was terrible. We're in recession territory still. Here you can see the inventory of new one family homes for sale and it's starting to come down. Builders are starting to clear probably with lower prices and we may see that intensify if during the next few months in response to the recent tick up back up in mortgage prices they're going to cut prices to clear their inventory. You can see this is an interesting new chart, US home buyers, the number of US home buyers which is in the purple. Those are down to 1.4 million people. And the number of sellers are two. And you can see that we've never at least in the history of this chart, it's a short history back to 2014. We've never seen this big of an imbalance between buyers and sellers. So here's a question for Kalshi around that mortgage rate. Will it average below 5.75 this year? And you can see there's a 19% chance. That is probably right. And the reason for that is, well, first let's show you where it is. We're at 6.4%. We've seen a little bit of a backup. It had ticked right below six. And so that five handle was getting people excited. But if we're right and the economy is really starting on the good side to take off and services follow, interest rates may not come back down that much more. So stay tuned. The clearing of the housing market may have to take place more through pricing than through interest rates.
Now, here's the good news. Capital spending is beginning to boom. Now, what's interesting about this chart, and I've watched it really since the early 90s, we peaked at roughly the same level every other cycle. And now we've blown out and are moving rapidly away from that former peak. So you know in the stock market when you say you've had a big base and it's lasted in this case 30 35 years the breakout is significant and probably will be sustained I think thanks to the deregulation and favorable tax policies here in the United States as I discussed earlier. Of course, the AI boom and the power boom is behind this, but we're even beginning to see capital spending away from those two spaces moving higher. And in fact, what's been so fascinating is Intel, Corning, Flextronics, now called Flex, names from the previous bubble. Cisco, are, oh, today AI, my goodness, it's been a single-digit grower for forever and it now it's gotten a hyperscaler order wanting to leverage off its content delivery network. So these are blasts from the past and it's basically saying that this AI boom is carrying the old guard along with it all hands on deck. Let's do this. So it's fascinating. But look at this. This surprised me. This is manufacturing construction for computer and electronics and it's into this year and I said what the heck this includes semiconductor manufacturing and other component manufacturing in the United States is going down. What's that? It's the CHIPS Act in 2022 which was part of the stimulus that year as trying to get us out of the COVID crash. And you can see how extended it was. We went from below 20 billion to $120 billion. So that's a six-fold increase and now we're down to 70. We think this is going to turn around for obvious reasons. And it will add to that non-defense capital spending chart that you just saw.
The trade deficit which is the last piece of GDP that we review we doubt is going to improve much from here because imports are increasing faster than exports and doesn't surprise us. We think our relative growth rate is higher than the rest of the world. So I've said this before, we don't worry about this deficit that much. Because the flip side of it is a capital surplus, again foreign direct investment coming into the United States, equity investment and so forth. Here we're into market indicators. And we're beginning to see slow, slow, but that metals to gold ratio in green there, it's trying to turn. Maybe more because gold is falling than metals increasing, but at least we're seeing some stabilization. We are not seeing much of improvement in the 10-year Treasury yield. But if growth picks up dramatically and the 10-year Treasury yield were to stay around here, that would suggest that the yield curve is going to continue flatten and perhaps invert in a recovery. And if we look back to the last technology revolution which was telephone, electricity, internal combustion engine building on the railroad ecosystem that had been built out in the United States during that period, the 50 years through the roaring 20s, the yield curve was inverted most of the time and the average inversion was roughly 100 basis points. Here is the price to gold ratio. As I've mentioned, a strategist I've always admired, Charles Gave of Gavekal, really believes that we're going back into a 70s style environment. And here you can see the S&P fell relative to gold very dramatically. He is focused on our deficit, the government deficit and our debt level. And I've already told you what we think about that. We disagree with him. We think this is going to reverse and we think it will go to all-time highs. We've got a little bit of a leading indicator here. Despite the rapid increase in oil prices, this ratio S&P to oil is closer to its all-time high. And we like to look at both gold and crude oil. Often do a ratio of them. But here with transitive property, you can see we're using the S&P and it's closer to its high. So we think it also will go to an all-time high because we really do think oil prices now that the UAE has moved out of OPEC that it's going to open the floodgates. It has been frustrated for years, years and years. And of course, we have Venezuelan oil gushing out as well. And the US, it is stunning. The US crude oil exports have gone from essentially zero in 2015 to 6 million barrels per day. And our production is at 13 million barrels per day. And this oil price is inviting, it's a clarion call for even more production. So we think we're going to see big drops in oil prices in the years ahead. And of course Russia is, it's the only way to finance the war, but it'll be the only way to finance its return from war and getting its economy back on track.
And finally in terms of at least, we have a few more indicators but these are the big four for us. Watching Bitcoin to gold. Bitcoin is moving up relative to gold. This would suggest that we've held the sort of the higher lows. The trend is up. Shall I say the trend is up over time and we do believe it is up over time. We would not be surprised to see gold continue to fall, especially if we're right on the dollar and Bitcoin continue to increase. And here two measures of risk, credit default swaps in the banking system, especially with the private credit debacle we've been saying. We've said it's not systemic. This would corroborate it. The latest tick here has been down. And finally, the high yield spread, high yield bonds or junk bonds relative to 10-year bonds in terms of their yields. Again, very low by historical standards. No spike in the aftermath of the private credit selloff here. So with that, that's good news. I know that the market has been trying for this year even though the market itself is up. The innovation space has been frustrating. Parts of it have done very well. Anything in space and defense tech has done very well. But anything touching software even fintech and the payments ecosystems they have been hurt and we think there's a lot of confusion sell now and ask questions later. So as you can see because we post our trades every day we've been picking some of the babies out of the bathwater as it's been thrown away. So, we're expecting though as the economy turns around dramatically, as July 4th gets closer, it is our 250 year old birthday party as a country and we think there's going to be a lot of optimism around that period. We hope that the administration gets what it wants in terms of the Clarity Act being passed by July 4th. That would be a boon for the crypto asset ecosystem. And we also of course pray, hope and pray that the Iran war and whatever it is right now that it is done and that oil prices are resolving on the downside of expectations, inflation as well which should drive consumer sentiment higher. We certainly think that the administration is trying to foster this scenario because of the midterm elections. Time is short and takes a long time for perceptions to change, but maybe our birthday party at 250 years old as an independent country will help the process along this time with it. So with that, I guess the next time I will be doing this is after Memorial Day weekend. So I hope you have a wonderful Memorial Day weekend here in the United States. And of course, we wish everyone in the world a wonderful springtime into summer.
