Surge in Defense Buoys Orders

Look for more aircraft orders in the second half.

Airplane in hangar
Diane Swonk

Diane Swonk

Chief Economist, KPMG US

+1 312-665-1000

 

Durable goods orders surged a stunning 1.9% in June, after rising at a 0.8% pace in May. A sharp 80.6% jump in defense aircraft and parts helped buoy those gains. That is the strongest jump in defense orders since December 2019; members of both parties are scrambling to boost spending to both aid Ukraine and provide a deterrence to the threat from Russia and other autocrats around the world. Orders excluding defense rose a more moderate 0.4%.

Within the transportation sector outside of defense, a pickup in orders for vehicles was tempered by a drop in nondefense orders. Supply chain problems are uncoiling in the chip sector, which is allowing the vehicle producers to catch up on backlogs. The pent-up demand for fleet sales, largely in the rental vehicle sector, remains strong. The vehicle producers prioritized higher margin retail over fleet sales when chip shortages were acute.

Aircraft orders picked up at the Farnborough Airshow in England in July. That suggests we could see a better second half in the aircraft sector for orders. Bottlenecks in supply chains are starting to improve but there is a threat of a major strike in the U.S. in the sector on Monday. That would be another setback for the industry if it occurs and cannot be resolved quickly.

Core durable goods orders, which strip out aircraft and defense orders and better track investing plans, rose 0.5% in June, the same as July. A sharp increase in computer orders helped to offset a drop in communications equipment. The biggest mover on communications equipment tends to be phone upgrades. A redesign of the iPhone in September could help with communications orders later in the year.

Machinery orders fell in June after posting strong gains in May. The drop was even larger after adjusting for inflation. The manufacturing indices from the regional Federal Reserve banks have been mixed, with some manufacturers still playing catch-up on delays triggered by the pandemic and others seeing their backlogs dry up. 

Core durable goods shipments, which feed into the quarterly GDP calculation, rose 0.7%. That is a slight slowdown from the pace we saw in April and May. However, those gains disappear after adjusting for inflation. Business investment is poised to contract in the overall GDP data in the second quarter, after surging in the first quarter.

Bottom Line. Businesses are growing more cautious about the outlook. That pessimism, coupled with escalating inflation, means that business investment actually declined in the second quarter after surging 10% in the first quarter. We cannot rule out a more persistent drop in investment by year-end, given the strength in the dollar and weakness in manufacturing activity abroad. Manufacturing activity in Europe was hit harder by the war in Ukraine and recent lockdowns in China.

Business investment is poised to contract in the overall GDP data in the second quarter.