US Durable Goods Orders Much Weaker than Expected

08-25-10 - New orders for durable goods rose a surprisingly modest 0.3% (month-over-month) in July following declines of -0.1% (previously -1.0%) and 0.7% (previously -0.8%) in June and May, respectively.  The increase was well below market expectations for a 3.0% gain going into today’s report.  The moderate increase in overall orders was the result of strength in the transportation component (led by rising aircraft orders) yet was almost entirely offset by weakness elsewhere.  Overall orders, excluding the transportation component, were down a disappointing -3.8% in the month following June’s modest 0.2% improvement.  The drop in ex-transportation orders was well below market expectations for a 0.5% gain.

Strength in today’s report was concentrated in rising aircraft and motor vehicle orders.  Orders for non-defence aircraft and parts were up an outsized 75.9% in the month following drops of -25.3% and -30.2% in June and May, respectively.  This result combined with a solid 5.3% increase in orders for motor vehicles and parts sent the transportation component up 13.1% in the month.  Gains in the transportation component, however, were almost entirely offset by weakness elsewhere.  Machinery orders were down a disappointing -15.0% in July, more than retracing the 4.3% and 11.1% gains recorded in June and May, respectively.  Orders for fabricated metal products (-1.0%), computers and electronic products (-2.4%), and electrical equipment (-5.9%) all declined in the month.  Orders for non-defence capital goods excluding aircraft (a leading indicator for investment in equipment and software) dropped a disappointing -8.0% in July.

In contrast with the decline in orders, durable goods shipments actually rose an encouraging 2.2% in July following a 0.2% increase in June; however, shipments of non-defence capital goods ex-aircraft were down -1.5%, breaking a string of five consecutive increases.  Inventories were up 0.6% following a 1.3% rise in June.  Unfilled orders dipped -0.1% in July.

Today’s report is disappointing. On its own, the sharp decline in non-defence orders ex-aircraft suggests that the pace of increase in equipment and software investment will likely moderate sharply in the third quarter of 2010 from the average 20.7% quarterly increase recorded in the first half of the year.  This situation suggests some downside risk to our current forecast that overall GDP growth will rise at a 2.5% annualized pace in the third quarter and compares to the 2.4% second-quarter advance estimate (we expect that it will be revised down by almost a percentage point later this week).  The monthly numbers, however, could be very volatile and, today’s report is in sharp contrast to earlier reported strength in industrial production in July.  With that said, labour markets have remained weaker than expected, and, while we expect the recovery in overall activity to be maintained, the pace will put only limited downward pressure on the unemployment rate in the near term.  The large labour market gap will keep inflation subdued, thereby permitting the Fed to maintain its monetary policy at accommodative levels until the recovery is more firmly entrenched.  As a result, we do not expect an increase in the Fed funds target from its current 0% to 0.25% range until well into next year.

Information contained in this report has been prepared by the Economics Department of RBC Financial Group based on information obtained from sources considered to be reliable. While every effort has been made to ensure accuracy and completeness, RBC Financial Group makes no such representation or warranty, express or implied. This report is for information purposes only and does not constitute an offer to sell or a solicitation to buy securities.