Underlying Investment Remains Strong

Durable goods orders fell 0.4% in September, much less than expected on a sharp drop in highly volatile civilian aircraft orders; defense orders for new aircraft more than doubled during the month as the government scrambled to get orders booked before the end of the fiscal year, October 1.

Vehicle orders fell for a second consecutive month as chip shortages continued to idle plants. Acute shortages and high prices have begun to take a toll on consumer demand, although fleet orders by the rental car companies are beginning to make a comeback. Hertz recently ordered more than 100,000 Teslas to offer customers, starting in November.

Core durable goods orders, which strip out volatile aircraft and defense orders and provide a better sense of business plans, rose a strong 0.8% in September after increasing 0.5% in August. All of those gains were concentrated in machinery, fabricated and primary metals. Orders for computers and electronics, and electrical equipment and appliances fell during the month. Computer chip shortages played a role.

Core shipments surged 1.4% in September, more than double the pace of August and sets us up for a strong start to the fourth quarter in October. Investment in equipment and intellectual property has been the strongest since the 1940s and will easily cross its precrisis peak in the fourth quarter. The one glitch is the strike at John Deere, which could disrupt orders and shipments of equipment for October. The strike started on October 14 and shows no signs of ending.

Separately, order backlogs continued to build in September but at a slower pace than we have seen in recent months. Inventories moved up a bit. Some of the fastest inventory gains were in the vehicle sector where dealers are struggling with shortages. Much of that increase in inventories appears to be coming from imports, which surged in the third quarter and will place a drag on overall GDP growth; hence, the long backlogs at U.S. ports. Disruptions due to the Delta variant in developing economies are beginning to abate amid signs that shipping costs may be in the process of peaking in October. (Cross your fingers.)

Bottom Line
Investment is robust and provides a much-needed boost to productivity growth. Those gains and a rebuilding of inventories will eventually help alleviate the upward pressure on overall inflation but not soon enough for the Federal Reserve. We are betting that the Fed moves to dampen inflation sooner and more aggressively in 2022, to hedge against inflation becoming entrenched. That would mark the first time that the Federal Reserve chased inflation since the 1980s. Since then, the Fed has been preoccupied with preempting a nonexistent surge in inflation. The pandemic continues to distort our world.

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