Heavy Manufacturing Demand Surprises to the Upside

Manufacturers’ new orders for durable goods declined by 0.2% in August; expectations were for a larger decrease.  This is the second consecutive drop in new orders; July orders fell by 0.1%.  A look under the hood shows a bit of resiliency from a number of key industries, which posted gains in August. 

A pronounced drop in nondefense aircraft and parts orders, -18.5% in August, contributed to the weak print in headline new orders.  The sharp decline in commercial aircraft orders should not come as a surprise since the U.K. Farnborough International Airshow took place in July.  Boeing orders throttled down to just 30 planes in August after a strong booking of 130 units in July, in which most were likely signed at the show due to pent up demand.  The 2022 Farnborough Airshow, which takes place every other year, was last held in 2018 as the 2020 show was cancelled due to COVID.  

Away from the weakness in aircraft orders, many other categories posted gains in August.  Indeed, excluding transportation, durable goods orders rose by 0.2%.  Electrical equipment orders rose by 1%, computers and electronics increased by 0.8%, primary metals orders, +0.4%, and machinery orders, +0.3%.  Meanwhile, fabricated metals orders fell by 0.7%.  

Even on a forward-looking basis, the news was unexpectedly good.  Core capital goods orders, which exclude aircraft and defense orders and are a proxy for business investment, jumped by 1.3%, scoring the largest increase since January of this year.  The direction is consistent with the rebound in the ISM new orders index that we saw in August of 51.3, climbing above the 50 breakeven threshold that delineates expanding or contracting manufacturing activity.  In both June and July, the Institute for Supply Management (ISM)’s new orders were below 50.  

Core capital goods shipments, an input into the Bureau of Economic Analysis (BEA)’s equipment investment for GDP, rose by 0.3% in August, in line with consensus expectations.  That follows a 0.5% increase in July for this category.  The firmness in core orders implies stronger equipment spending in Q3.  However, weakness in manufacturers’ inventories acts as an offset.  Collectively, the tracking estimate for Q3 real GDP growth now stands at 2.1% on a seasonally adjusted, annualized basis.  

Bottom Line

There is a bit of cognitive dissonance from the August durable goods orders report, which is the mental discomfort that arises from holding two conflicting beliefs.  While the underlying data bring welcome news for the factory sector, we know that interest rates are headed sharply higher. Monetary policy is squarely in restrictive territory with more rate hikes ahead.  The U.S. Treasury 10-year yield is sharply higher, yielding nearly 3.90%, which puts further upward pressure on capital costs and is likely to inhibit future capital investment.  With recession risks rising for the U.S. and global economies, we see a difficult path for the manufacturing sector going forward.