Bank of the West U.S. Outlook Report for March 27, 2015
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US Outlook Report: What Does the Drop in New Orders Mean?
What’s the saying, “Get used to disappointment”? Despite expectations for stabilization, durable goods orders for February remained weaker than expected, dropping another 1.4% on the month. Non-defense capital goods orders, excluding aircraft, often a leading indicator of business investment and industrial production, has dropped now for six consecutive months. This is the longest consecutive monthly decline since September 2012, when orders fell for seven months and culminated in the launch of QE3 at that month’s FOMC meeting. Does that mean QE4 is in our near future? Probably not, but it does help explain the FOMC’s dovish statement and caution about raising interest rates over the near-term.
I see three factors driving this downturn in orders: 1) the rapid strengthening of the U.S. dollar 2) the huge and unexpected plunge in crude oil prices, and 3) the harsh winter weather. The effects of the bad-winter weather are expected to be transitory and should already be fading in March. The impact on manufacturing and business investment from the other drivers is likely to be longer-lasting. The strong dollar is likely the most powerful factor and probably will be the most prolonged of the three. U.S. goods exports are already 3.9 percent lower than a year ago.
Inventory shipment ratios have been on the rise and are now out of whack with current demand. The all-manufacturers inventory to shipments ratio hit 1.4 in January – meaning inventories are higher than normal relative to shipments. This is the highest ratio since the “Great Recession”. Inventory shipment ratios for computers and electronic products and non-durable apparel manufacturers appear especially high by historical standards, indicating the rise is likely due to an adverse impact from the strong U.S. dollar and weak global demand. This could mean future cuts in production and jobs in these sectors until shipments improve.
In short, even if orders pick up from here, it will take several more months before inventories come back in-line with demand, which suggests continued weakness in manufacturing surveys and production in the months ahead.
On the bright-side, a modest manufacturing slowdown or downturn doesn’t necessarily lead to out-right recession. Manufacturing employs only 12.3 million people or 8.7% of total nonfarm payrolls of 141.1 million. But there are multiplier effects on the rest of the economy. During the 2012 manufacturing slowdown, industrial production growth slipped from 4.5% (year-on-year) to 2.3% (a 2.2 percentage point decline in growth). Over the same period, real GDP growth fell about 1.1 percentage points from 2.7% to 1.6%.
The U.S. economy has gotten off to another shaky start, much as it did in Q1 of last year. Tracking estimates of the current quarter’s real GDP growth are around 1.5 percent annualized. We lowered our forecast for business investment and exports in Q1 this week and project slightly slower growth from these sectors in Q2 as well, including industrial production growth. The lingering weakness in this month’s durable goods orders and the resulting inventory overhang that has developed will see to that.
To find out more, check out this week’s US Outlook Report.
Tags: economy