Dismal Data Drives Down Dollar

Considerably weaker-than-expected durable goods orders in July cast doubts on the momentum of the US economy in early Q3 as the market contemplates Fed tapering.

Wasn't Expected
The 7.3% headline decline contrasts with expectations for a 4% decline, while the June gain was pared to 3.9% from 4.2%. This is a volatile series for sure as bit ticket items skew the report. Aircraft orders were off 52.3%, for example after rising 33.8% in June.

Excluding transportation orders, a 0.6% decline would have been recorded. This however, still overstates the case, as defense orders flattered the data as well. Excluding transportation and defense orders, durable goods orders fell 3.3% compared with an expectation of a 0.5% gain. It more than offsets the 1.3% rise in June. This suggests that capital expenditures will be be a drag on GDP in early Q3 and the softness in shipments (-0.3%) would lend credence to this interpretation. At the same time, we note that inventories rose 0.4%, the biggest increase since February. Many economists who expect the US economy to accelerate in H2 anticipate that a rebuilding of inventories.

Other Softness
There was some softness in computer/electronic equipment orders that probably bears paying attention to going forward. Overall though the recent strength of the durable goods orders on a trend basis, and the volatility of this time series, means that it is unlikely to play a decisive role in shaping expectations for the US economy here in Q3 or the Fed's tapering decision next month.

Asymmetrically Vulnerable
The price action -- quick dollar drop across the board, including against many of the emerging market currencies -- and rally in bonds -- illustrate one of our key interpretative points: the market has discounted Fed tapering and is asymmetrically vulnerable to soft data. We are not so much forecasting what the Fed will do in September. Rather our point is that the odds of tapering do not appear as great as the market appears to pricing in and the size may be more modest than the $20 bln that market had initially expected (and was mentioned again at Jackon Hole).