Beige Book Report: Cleveland
October 10, 1979
Business conditions in the Fourth District have improved during September, but most respondents view a positive third quarter as temporary. Strength in retail sales is credited to a comeback in auto sales which is not expected to carry over into the fourth quarter. Production of capital goods is expected to remain strong this quarter, but reduced operating rates in steel are anticipated. Bankers report strong loan demand, which may reflect the weakened financial position among businesses and consumers. Despite a stronger than expected level of housing starts, several housing market officials believe the marginal buyer is being squeezed out of the housing market by continuously rising prices and interest rates. Continued high rate of price increases will prevail in the fourth quarter with only a few exceptions.
Growth of retail sales has slowed in the District, but department store officials are skeptical that the economy is in the midst of a recession. One retail economist noted that real sales of department store-type goods have flattened, but have not yet declined. Other retailers assert that price-adjusted sales are biased downward because consumers have been responding to differences in relative prices. Apparel sales, for example, have been excellent in recent weeks, reflecting a price increase of only half the 13 percent increase in the consumer price index. However, retailers are concerned about diminishing profit margins, rising loan delinquencies, and bad-debt losses. Indeed, most respondents stated that retail sales would have been negative in September except for the pickup in auto sales. The strength in auto sales, which was induced by rebates, may have come at the expense of fourth-quarter sales, according to some officials.
Durable goods manufacturing has tended to hold up better than had been expected, partly because housing and related industries have been better than expected. However, a supplier to the appliance industry reports that orders have tended to weaken and backlogs reduced in recent weeks. An economist for an aluminum producer views the decline in orders for packaging materials as an indication of a further slowdown. Finally, a retailer believes some softness in overall business sales stems from tight control over inventories, and hence new orders, by retailers.
Capital goods producers, except for auto and truck-related industries, report that business has been buoyed by a need for additional facilities, and production is expected to remain strong in the fourth quarter. According to one District economist, high utilization rates and sluggish investment during most of the expansion have made the need for fixed investment apparent. However, a durable goods manufacturer expected businessmen to be cautious because of a lack of funds for investment. A steel economist states that steel orders have dropped to about half the rate in the first two quarters of 1979, when orders exceeded shipments and backlogs rose rapidly. Probable shipments for the second half of 1979 are 7.5 million tons, compared with 8.5 million tons in the first half. Operating rates in the steel industry will hover around 80 percent in the second half, compared with 90 percent in the first half of 1979. However, demand for steel from energy, freight cars, heavy construction, and machinery remains strong.
Continued strength in business and consumer loans can be attributed in part to deterioration in the financial position of businesses and households. A banker expresses concern that strong commercial loan demand was the result of a weakening cash flow position among producers. External financing for new model changeovers is cited by one auto economist as a source for increased demand for business loans. On the consumer side, a banker mentions consolidation of debt as a source of consumer loan demand. Indeed, delinquency rates have been climbing. But most of the consumer demand, according to one banker, has been for installment loans and credit card usage. Several bankers note a rise in precautionary borrowing by business and consumers as a hedge against higher interest rates.
Higher interest rates are having a noticeable effect on both borrowers and lenders in the mortgage market, and are expected to contribute to a decline in mortgage demand and housing starts. Several bankers and housing economists expect 1.5 million and 1.6 million in starts during the fourth quarter. However, several savings and loan associations report growing difficulties in financing mortgages because of weak deposit flows and narrowing profit margins brought about by a negative yield curve. One savings and loan official explains that the appearance of adequate liquidity may be misleading because a great reliance on jumbo certificates of deposit (CDs) requires savings and loan associations to maintain a higher liquidity position in case the jumbo CDs cannot be rolled over. Although the cost of funds has been high, a savings and loan official states that mortgages are still being made on the expectation that mortgage interest rates will decline next year and that profits can still be made on points during the first year of a new mortgage.
Moderation in the inflation rate has not yet occurred, but businessmen look for some relief in response to a slowdown in economic activity. A steel economist believes that steel scrap prices will drop further because of lower operating rates in the steel industry. However, a durable goods producer expected little change from double-digit inflation until 1980. An energy economist believes that gasoline supplies in most parts of the District will probably exceed demand this month, and the price in the near term will rise less rapidly than natural gas and electricity prices. The rise in food prices is expected to be near the overall inflation rate in 1980.