Durable Goods Orders Ended the Second Quarter on a Strong Note

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Overview

Coffee and Economic Review

Global stocks rose on Friday as strong company earnings and an easing of trade tensions between the United States and Europe boosted investor confidence. The MSCI All-Country Index, which tracks shares in 47 countries, was up 0.1% on Friday, the sixth straight session of gains, a run not seen since February. European stocks inched up in early trade and were set to end the week at six week highs, helped by an easing of U.S. tariffs and good company results. The U.S.-EU trade agreement to negotiate tariff reductions and increase U.S. exports to the U.S. is regarded as a stepping stone and may lower the risk of new U.S. tariffs on auto imports. However, the lack of specifics and the possibility that, negotiations could falter at a later stage, have not totally eased trade tensions. Although it may be a positive step, the actions may be interpreted as a sign that trade relations with China may get worse, as the U.S may choose to align with the EU on trade policies. The deal between Donald Trump and Junker is viewed as not really a deal yet, but it is a step away from the brink.

 

U.S. stocks edged lower on Friday as the GDP report showed a strong economy. Real GDP increased at an annual rate of 4.1% in the second quarter, following a revised 2.2% increase in the first quarter. The report included benchmark revisions, which incorporate new methodologies and data sources. Real GDP growth has averaged a 2.3% pace from the end of 2012 to the first quarter of 2018. That was unchanged from the original estimate but the mix was changed. Business investment rose at a slightly higher pace and consumer spending slightly less. The trade deficit looked a little worse. The important point is that while we are unlikely to see a repeat of the second quarter strength, growth is being led by business investment and the tax changes did benefit businesses. Another important point is that a lot of the second quarter strength was led by one-time factors. One important contributor was trade, where soybeans were rushed to export markets ahead of the advent of tariffs and contributed 1.1% to growth, which is unlikely to be repeated.

 

The economy remains strong and is likely to track near 3% well into 2019. However, powering this growth is the massive fiscal stimulus, that is, deficit financed tax cuts and government spending increases. Growth at that rate is not sustainable for long unless there is a significant pick-up in potential growth. Unless productivity picks up, or there is a large increase in the labor force, growth will return to its long term trend when the stimulus fades. The biggest risk is trade and political tensions are increasing as we get closer to the mid-term elections.

 

Durable goods orders ended the second quarter on a strong note. New orders rose 1.0% in June, fueled by civilian aircraft orders. Core capital goods orders rose 0.6% and at a 10.9% pace for the second quarter. Next week will be busy on the economic calendar.  We will get a look at personal income and outlays, pending home sales, motor vehicle sales, the ISM manufacturing and non-manufacturing indexes, construction spending, factory orders, employment and international trade.

Latest Data

The U.S. Economy:

The pace of economic growth picked up in June. The Chicago Fed National Activity Index increased to .43 in June, up from -0.45 in May. Two of the four broad categories that make up the index increased from May and three out of the four categories made a positive contribution to the index. The three-month moving average was unchanged in June at 0.15%. Production related indicators contributed 0.36 to the index, up from -0.56 in May. Employment related indicators contributed 0.08 to the index, down slightly from 0.11 in May. A zero value to the index has been associated with the national economy expanding at is historical trend.

 

Existing home sales fell for the third straight month in June. Sales fell 0.6% from May to an annual pace of 5.38 million units. The decline in sales was led by the South and West, though sales in the Midwest and Northeast did increase. Sales in the West and South may have been affected by the hot weather in June that did reduce prospective buyer traffic. Listings have increased so the probability that the three-month decline is economic in nature. Mortgage rates are trending higher and confidence may be a factor. President Trump’s trade policy is making businesses and consumers more uncertain about the future of the economy. Inventories of single-family homes totaled 1.74 million, up 4.8% from May and up 1.2% from a year earlier. Price growth is slowing and the additional listings should keep downward pressure on price. The market may have, indeed turned downwards, but a few more months are still needed to establish a trend.

  Durable goods orders advanced 1% in June, rebounding from a two-month consecutive loss. June’s result was led by the volatile transportation sector, where aircraft orders increased 20.2%. The important core capital goods segment rose 0.6% and shipments in that area were up 1.0%. New orders for motor vehicles and parts increased 4.4%, rebounding from a fire that damaged an auto parts factory. Manufacturing is holding up, but goods producers are assessing the Trump administration’s trade policies. Recent survey data suggests that trade policy uncertainty and the prospects of a trade war are weighing in on investment plans. So far, fundamentals remain healthy, but there are labor constraints and rising borrowing costs. The global economy is fine but may be nearing peak growth. If global trade falls, there will be repercussions in the USA.

 

The advance international trade deficit widened significantly in June. The preliminary goods numbers show a deficit of $68.3 billion, up $3.6 billion from May. Nominal goods exports fell 1.5%, while imports gained 0.6%. A large 8.5% decline in consumer goods exports drove a large part of the export decline. Exports are still up almost 11% for the year as the global economy is driving demand. The dollar is up nearly 5% from January so further advances in exports may slow in response. The bulk of the tariffs to China came in effect in early July so the next trade report may show a different trend.

 

Inventories paused in June. Wholesale stocks were unchanged, following a 0.4% increase in May. Auto inventories fell 0.3% and retailers excluding autos increased 0.3%. Sales have been picking up, allowing stocks to fall but clearing the deck for further production increases. Slower sales in the auto sector suggest another inventory correction may be needed.

International:

Euro-area business growth slowed more than expected this month as fears over a trade war with the U.S. and a weaker global expansion put another dent into optimism. The Composite PMI dipped in July to 54.3 from June’s 54.9. If maintained, the latest PMI points to economic growth of 0.4% for the euro zone. Manufacturers had a better July, with the factory PMI rising to 55.1 from 54.9.

Important Data Releases This Week

June pending home sales will be released on Monday, July 30 at 10:00 AM EDT. Pending home sales are expected to rise 0.8% in June after the 0.5% rise in May. The index has been accurately forecasting on trend the flat to declining existing home sales market.

 

June personal income and spending will be released on Tuesday, July 31 at 8:30 AM EDT. We expect personal income to rise 0.4% in June, the same as in the previous month. Nominal spending will rise 0.4%, with a little contribution from vehicle sales. The core GDP deflator is expected to rise 0.2%, bringing year-over-year growth to 2.0%.

 

July ISM manufacturing index will be released on Wednesday, August 1 at 10:00 AM EST. The ISM manufacturing index is staying elevated. Near record delivery delays and a plus 75 reading for input costs will allow the index to retreat slightly in July to 59.4 from the 60.2 reading in June.

 

July vehicle sales will be released on Wednesday, August 1 at 4:00 PM EST. July vehicle sales are likely to see a slight reduction to 17.1 million from June’s strong 17.5 million pace.

 

June construction spending will be released on Wednesday, August 1 at 10:00 AM EST. Construction spending is expected to post a decent 0.3% increase in June after the weak 0.4% increase in May. May’s report was led by multifamily housing, offsetting another choppy performance for the non-residential sector.

 

June factory orders will be released on Thursday, August 2 at 10:00 AM EDT. Durable goods for June were helped by aircraft orders. Orders excluding transportation were modest and core capital goods orders were solid. Orders should rise 0.8% in June, with help from nondurable goods.

 

July payroll employment will be released on Friday, August 3 at 8:300 AM EST. Following a solid May with 213,000 jobs were created, a less bright addition of 188,000 can be expected for July. We expect wages to grow 0.3% bringing the year-over-year total to 2.7%.

 

June International trade in goods will be released on Friday, August 3 at 8:30 AM EDT. We look for the trade deficit to widen to $45.6 billion from May’s $43.1 billion. The goods side of this report has been released and showed a sizable widening as exports fell and import growth held steady.

 

July ISM non-manufacturing index will be released on Friday, August 3 at 10:00 AM EST. The ISM non-manufacturing index is staying elevated. The index is expected to decrease to 58.8, down from June’s 59.1 reading.


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