Minor Gains for Durable Goods and Construction Spending

Durable goods orders rose 0.4% in January, buoyed by gains in defense and nondefense aircraft orders. Orders for new vehicles fell and will likely be down again in February given the weakness we have seen in vehicle sales since the start of the year. The fate of Boeing orders in the wake of crashes of its 737 Max planes remains unknown. Boeing still has a substantial backlog of orders and is running behind on deliveries, but cancellations and loss of market share to Airbus are possible. Gains by Airbus would shift more production away from the U.S.

Capital goods orders, which more closely track the investment plans of companies, jumped 0.8% in January. That is the strongest pace in six months and hopefully a sign of better news to come on the investment front. Gains in machinery, computers and communications equipment helped buoy gains in January, but did not fully reverse the losses late last year.

Core shipments, which go into the calculation of real GDP growth in the first quarter, also rose 0.8%. Our forecast for modest gains in equipment spending in the first quarter remain intact. A pickup in domestic demand appears to be offsetting weakness abroad. The key to the outlook for the rest of the year relies heavily on the price of oil, which is firming but remains too low to justify a lot more investment in the shale industry. Shale investors have grown more cautious in recent years, focusing more on returns from existing fields than adding to capacity.

Construction spending jumped 1.3% in January, but only after being revised down in December and November. Gains in public sector construction activity were the largest. Highway construction posted another month of double-digit gains. Anyone who drives on a highway knows that those gains were not enough to keep up with potholes, let alone make repairs and upgrades to our dilapidated public infrastructure.

Commercial construction also posted gains but they were uneven. Multifamily construction picked up as builders continued to attempt to meet demand for rentals. Construction of offices and lodging also increased, while retail construction contracted. Indeed, many categories of private sector construction activity are now falling at a double-digit pace from a year ago. The move to build warehouses to fulfill more orders online still lags the closures of more traditional brick and mortar retailers.

Single-family housing construction continued to contract in January. Builders are hopeful that we will see a reversal of that trend in Spring; single-family starts were actually up in January. The problem is composition. The drop in mortgage rates since the start of the year has brought wealthy, second-home buyers back to the market; first-time buyers, who were already lagging previous generations, remain scarce. Elevated prices in the hottest job markets and an overhang of student debt has caused millennials to delay purchasing homes. This is at the same time that builders complain that rising land, labor and materials costs have made it difficult for them to move downstream and build less expensive, entry-level homes. Lumber tariffs added 8% to the cost of building a home, according to some builders.

Separately, the Producer Price Index (PPI) rose 0.1% in February on a modest rebound in energy prices. That was the first increase in four months but not enough to stem a further cooling in underlying inflation pressures. The PPI slowed from a 2% year-over-year pace in January to a 1.9% year-over-year pace in February.

Core PPI, which excludes food, energy and trade service costs, was also up 0.1% in February. A moderation in airfares and transportation and warehousing partially offset a pickup in core service costs. The year-over-year read on core PPI cooled from 2.5% in January to 2.3% in February. That marks a 14-month low and will further shore up the Federal Reserve’s decision to stay on the sidelines next week.

Bottom Line
The flurry of data that came out today had a silver lining for investment, at least in the near term. We seem to be stemming the losses during the latter part of 2018. That doesn’t change the outlook for the first quarter, which is now in the low 1% range, nor the Federal Reserve’s move to the sidelines in January. In fact, most data has surprised to the downside instead of the upside since the Fed last met, a reality that Fed Chairman Jay Powell will have to address at the press conference following the Fed meeting. Look for the Fed to mark down its concensus forecast for growth and expectations for rate hikes. We also expect the Fed to announce plans to halt reductions in its balance sheet next week.

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