MARKET TRENDS: Housing Upsurge Offsets Fall in Durable Goods Orders and Manufacturing

Following the strong report on nonfarm payroll and retail sales, both durable goods orders and manufacturing PMI disappointed the market in May. This is in addition to a drop in the Chicago Fed Manufacturing Index on Monday. However, a reviving housing market induces optimism in the strength of the U.S. economy going forward.

The durable goods orders, which include heavy and bulky goods like trains, planes and automobiles that can be used for a longer period of time, fell unexpectedly in May due to lower demand in the commercial aircraft sector. The core durable goods orders, which exclude transportation, also missed the estimates.

The manufacturing activities grew at the slowest pace since October 2013. Manufacturing was pressured by investment spending cuts in the energy sector after an over 60% drop in crude oil prices, coupled with a strengthening U.S. dollar. The dollar has gained about 12% since June 2014, eating into the profits of multinational corporations.

Oilfield companies like Schlumberger and Halliburton are expected to slash their capital expenditure budgets for this year as the U.S. oil drilling rig counts dropped to near five-year lows. However, the pace of decline in the oil rig counts has slowed in recent weeks as crude prices has shown some recovery.

Durable goods orders declined 1.8% month-over-month (MoM) in May, primarily due to a lower demand for commercial aircraft, said the U.S. Department of Commerce on Tuesday. The market expected a 0.6% drop in durable goods orders. In April, orders declined by a revised 1.5% on a steep fall in aircraft-related orders.

Orders excluding transportation rebounded on a higher demand for metal parts, heavy machinery and networking equipment. The core durable goods orders increased 0.5% in May, but still missed the market forecasts of an increase of 0.6%.

In April, core orders were down by a revised 0.3% on lower business investments, hurt by a strengthening U.S. dollar and lower energy prices. Business investments dropped 2.6% in the first five months of 2015 compared to one year ago.

However, the recent surge in orders for core capital goods, a gauge of business investment, indicates a stabilizing manufacturing sector. Core capital goods orders inched up 0.4% MoM in May. Shipments of core capital goods, an indicator of quarterly economic growth, increased 0.3% in May. Inventories were down for the first time in nearly two years.

Market research firm, Markit, reported its preliminary U.S. Manufacturing Purchasing Managers’ Index of 53.4 in June, down from 54.0 in May – with market forecasts of 54.2. The drop in the Headline Index was led by a fall in the Production Index to 53.9 in June from 55.2 in May. June production was at its lowest level since January 2014.

Slower growth in total new businesses resulted in a weaker rise in production volumes. New orders rose with the New Order Index moving up slightly to 54.5 in June from 54.3 in the previous month. New order volumes grew at the weakest rate in 16 months in May.

The sharp fall in the Production Index offset the gains in the Employment Index which was at its highest since November 2014. A reading above 50.0 indicates expansion, while anything below that is contraction.

After an unexpected rise in existing home sales, purchases of new homes in the U.S. soared 2.2% MoM to 546,000 units. This is the strongest gain since February 2008, led by the Northeast and West in May.

Strong job growth and an improving wage rate drove demand in the real estate sector. Northeast sales increased by a whopping 87.5% in May after a slowdown due to harsh winter weather. Such high gains are most likely to be temporary.

New home sales jumped 13.1% in the West. In the Midwest and South, home sales declined. New home sales fell slightly by 1% over the past 12 months to $282,800. The supply of new homes dwindled to 4.5 months, compared to the 6 months’ supply generally associated with a healthy market.

Still, homebuilders seem to be confident as building permits expanded 11.8% to 1.28 mn, the highest level since August 2007, the Department of Commerce reported last week. Existing homes sales also climbed 5.1% in May to 5.35 mn on Monday.

Borrowing costs have been at historic lows, but have been rising recently. This may further trigger housing demand. Average 30-year fixed rates were at 4.04%.

The construction sector could see a sharp rise in hiring which will further pull up the overall employment level, resulting in broader economic growth. This could offset the manufacturing sector fall back.

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