Oops, a Downside Surprise
By Michael Englund and Rick MacDonald
After a string of data reports indicating a solid upward trajectory for the economy, Wall Street was tossed a curve on June 23: U.S. durable-goods orders fell 1.6% in May, vs. market expectations of a 1.5% rise. The report measures the number of new orders for goods intended to last at least three years placed with domestic manufacturers for immediate and future delivery. It's widely considered an important gauge of the factory sector's health.
The soft headline figure for May is at odds with the strength revealed in other factory-sector barometers, including the most recent Institute for Supply Management survey and reports on factory employment and industrial production. The May durable-goods report revealed widespread weakness during the month for orders, shipments, and inventories, though that was slightly mitigated by upward revisions in nearly all of the data for April. And after extraordinary gains in durables data through February and March, nearly all of the data in the current-month report reveal some downside corrections in the figures in April and May.
For the aggregate data, orders declined 1.6% in May following an upwardly revised 2.6% drop in April -- reversing half of the surprising gains of 3.9% in February and 5.9% in March. Shipments also fell for the second month in a row, by 0.7%, following a 0.8% drop in April, though these drops reversed only about a quarter of the gains seen in February and March of 1.4% and 4.4%, respectively.
Data on orders for nondefense capital goods followed a similar pattern to the headline figure, declining after a strong end to the first quarter. Shipments fell 2% in May, also partly reversing the 3.4% gain in March, though the interim figure for April posted a slight gain of 0.8%. Orders for the equipment sector fell 2.6% in May following a 1.2% drop in April, and here the data give back about one-third of the huge February and March gains of 4.1% and 6.2%.
Among other highlights of the report, shipments of durable goods slipped 0.7% in May following April's revised 0.8% drop. Durable inventories climbed 0.4%, which allowed the inventory-to-sales ratio to firm to 1.38 from 1.37.
In the wake of the weaker-than-expected May report, we at Action Economics have revised our second-quarter gross domestic product estimate downward to a 5% gain, from 5.3%, following a revised 4% first-quarter increase that we previously expected (from 4.4%), given weakness in trade. We now expect second-quarter growth of "only" 11% in fixed investment and 13% in equipment and software spending -- solid numbers nonetheless. Business inventories should rise 0.6% in all three months of the second quarter, while inventories should add $10 billion to $20 billion to GDP growth for the period.
Though the factory sector remains robust, the May durable-goods data suggest less of a one-sided mix of figures for factories, as previous data have revealed an unusual string of upside surprises to virtually all of the factory sector data that left open the potential for a substantial upside "breakout" for the sector. Now, growth looks brisk, but with a less likelihood of big positive jumps as we enter the third quarter. However, at Action Economics, we still expect GDP growth to top consensus views for the remainder of 2004.
How might the Federal Reserve view these numbers? Certainly, the market's nearly unanimous expectation is that Alan Greenspan & Co. will opt for a quarter-point rate hike on June 30. But less-stellar growth in the factory sector -- along with ongoing geopolitical risks -- substantially reduces the likelihood of an unexpectedly large Fed tightening move at either the June or August FOMC meetings.
Englund is chief economist, and MacDonald is director of global research and analysis, for Action Economics