March 14, 1979
Manufacturing activity in the fourth district has risen to effective capacity in a number of industries with no signs of impending letup. Primary metal producers report order books are full through the first half of 1979 and capital goods producers are generally more bullish now than late last fall. Economists who attended the March 9 meeting on the economic outlook held at this bank, expect a recession to begin in the second half of 1979 and have also scaled up their expectations for inflation this year. S&Ls expect sharply reduced deposit flows as a result of March 15 changes in money market certificates. Financial problems in the City of Cleveland remain unresolved despite the voter passage of an income tax increase.
Manufacturing in the district is virtually at effective capacity in a number of key industries, especially primary metals, capital goods, fabricated metals, and rubber and plastic products. References to parallels with 1973-1974 are becoming more frequent, and some concerns have begun to surface that a typical inventory cycle may be developing. Capital goods producers have been stepping up inventory building in response to strengthened orders and backlogs.
Fourth district economists who attended a meeting on the outlook at this bank on March 9, lowered their expectations for output in 1979 from estimates last November. The median forecast of a group of 29 economists shows a gain in real GNP at a 1.8 percent annual rate in the first half of 1979, followed by a 1.3 percent rate of decline in the second half, and a 1 percent rate of increase in the first quarter of 1980. Only four of the group expect a recession to begin in the second quarter of 1979, but 15 of 29 indicate a decline in real GNP in the third quarter and 20 of 29 expect a decline again in the fourth quarter. The projected recession is expected to be mild and brief because of a lack of major excesses or imbalances, a less- than-typical decline in housing, gradual improvement in net exports, and continued strength in fixed investment. They expect the rate of inflation to be 8.5 percent, 7.9 percent, 7.0 percent, and 6.8 percent from the first quarter of 1979 through the fourth quarter, respectively, and the unemployment rate to edge up to 6.8 percent in the fourth quarter of 1979. Several expressed a view that public policy makers should take additional risks now to bring the rate of inflation under control, which includes holding down growth of monetary aggregates, should a sharp rebound occur.
Economists scaled down their expectations for consumer spending from last fall. They now expect nominal consumer spending to slow to nearly an 8 percent annual rate of increase in the second half of 1979 following an expected 10 percent increase in the first half. A group of seven automotive producers and suppliers now expect domestic new car sales will amount to nearly 8.8 million units in 1979 plus 1.8 million imports. An automotive economist discounts the runup in consumer installment debt unless a sustained decline in real income occurs. He indicated that recent increases in gas prices have already contributed to a further shift from middle-sized to compact cars and believes that unlike the experience following the oil embargo in 1974, higher gas prices may have a positive effect on car sales because cars on the road are less fuel efficient. Some other economists, however, note that the high rate of inflation has substantially changed consumer spending patterns, especially for nondurable goods, and are skeptical that spending for these types of goods will be insulated from a recession.
One notes that consumers have resisted higher relative prices for nondurable goods while buying goods that represent a hedge against inflation. An economist with a major department store chain expects a drop in real GAF sales this quarter, which is likely to continue into the summer because of double-digit inflation and slower employment and income gains. He believes a peak in GAF sales occurred last October, and since then, sales have been relatively flat, contrary to the surge reported last quarter in nondurable goods sales in national product accounts.
Economists are considerably more optimistic than they were last fall that business fixed investment will show stronger gains in 1979 than indicated in recent surveys. They now expect a nominal 13.8 percent increase in 1979 on the strength of accelerated rates of increases in orders and backlogs in the last six months. Machine tool orders in the first two months of 1979 rose significantly from the comparable period of 1978, which leads one economist to assert that the present phase is similar to early 1956 and 1973, and may tend to prolong the expansion although at a slow rate of growth. Another economist concluded that the economy has moved into a typical advanced stage of an expansion in which fixed investment replaces consumer spending as a prime source of thrust to economic activity. Nevertheless, there are still some weaknesses or expected weaknesses among segments of capital goods industries. Demand from utilities for electrical generators remains weak, and heavy-duty truck production is expected to fall sharply by next fall in response to slowing sales and record inventories.
Some petroleum refineries in the district have announced allocation of gas supplies this month that are generally based on 100 percent of year-ago volume in order to stretch out gasoline supplies. In some cases, district-based refineries were picking up additional business from refineries that earlier announced cutbacks in supplies to local retailers.
S&Ls in the district expect that March 15 restrictions on money market certificates will sharply curtail growth of deposit flows and mortgage credit and probably lead to further near-term tightening in mortgage terms. Some feel the certificates were threatening the liquidity and profitability of some associations. An official with a major Ohio association, for example, stated that if growth of certificates continued at the rate of the past six months, by the end of 1979, 25 percent of their deposits would be in certificates and profitability would have been cut by more than one-half. Some others feel profitability has not been that much of a problem, but may worsen because deposit outflows will accelerate as certificates mature. Loan commitments have not been as strong as last year because some lenders have been unwilling to make 90 percent mortgage loans and some have been unwilling to make 80 percent loans except to their customers. The feeling at some S&Ls seems to be that competition for funds, once the cap is effective, will be fierce, as associations set up promotional activity to retain funds and attract new deposits.
Voters in Cleveland approved a 50 percent income tax hike and rejected the sale of the Municipal Light Plant, but financial problems appear to be far from over. While generating an estimated $25 million this year in new tax revenues to deal with an accumulated $100 million debt, the city still must confront two obstacles in order to return to the bond market. First, without cash from the sale of Muny Light, the city is unlikely to be able to repurchase either the defaulted notes worth $15 million or the $26 million in notes that mature by September. Second, the new tax is not sufficient to reestablish investor confidence in the financial integrity of the city. The State Legislature is currently debating the form that state aid might take. Legislative action is expected to be slow despite the fear of unmet payrolls in Cleveland and of the spillover of financial problems into the school system and the suburbs.