Beige Book Report: Cleveland
November 14, 1979
Most bankers and economists in the Fourth District believe that October 6 policy changes have virtually ended prospects for a soft-landing and have increased prospects for a deeper than previously anticipated recession. While the capital goods sector is still experiencing backlogs, economists are concerned that the higher cost of financing inventories will cause inventories and hence new orders to be reduced. However, some abatement in inflation is expected in 1980. Banks have generally tightened credit and raised interest rates for mortgage, installment and C&I loans. The housing market is now expected to be slow through the first half of 1980.
The 26 economists who attended the Fourth District Economists Round Table meeting held at this Bank on November 9 generally agree that the economy has already peaked. All but two expect a decline in real GNP in the fourth quarter of 1979; the median forecast of the group indicates a 2.1% decline in real GNP from the third quarter of 1979 through the third quarter of 1980, considerably deeper than they expected last June. However, at least three scenarios emerged with respect to the outlook. Despite weakening auto production to 9.7 million in 1980 compared to 10.4 in 1979, an auto industry economist expects a brief, mild recession in the first half of 1980, followed by a mild recovery in the second half. Mortgage markets have improved because of structural changes, inventories are more tightly-controlled, and money stock growth will likely remain at about the same rate as 1979. However, a bank economist feels that classical business cycle adjustments will override the structural changes. Thus, the need to rebuild savings and reduce debt levels as employment declines will tend to weaken the recovery. Several economists point out that stepped-up consumer spending during the third quarter of 1979 to avoid higher prices may have been a form of savings for consumers. Finally, an economist for a durable goods producer expects a sharp recovery after mid-1980, based largely on a 350 basis point decline in short-term interest rates by spring 1980 and a substantial tax cut for businesses and consumers late next year.
Auto producers and suppliers have scaled down their estimates of domestic car sales and production for this quarter and for 1980. A group of eight economists now expects domestic new car sales this quarter of about 2.1 million units and 8.1 million units next year. Dealers claim carrying costs of new car inventories have jumped to as high as $150 monthly per car, and assert that dealers will trim stocks and orders.
Capital goods producers continue to be relatively optimistic, with one official in specialized machinery expecting backlogs to carry plant and equipment expenditures through the first half of 1980. However, a bank economist notes that nonresidential spending and real nondefense orders have already peaked. An economist with a transportation equipment firm considers the truck cycle to be in an early contraction phase that will continue through the third quarter of 1980, followed by a strong rebound in truck sales. Thus, the recovery should be lead by capital expenditures.
Several economists state that businesses have pursued cautious inventory policies and perceive little inventory problems, except for automobile and auto-related industries. However, one major tire producer reports no serious inventory accumulation either at the plant or among its dealers. Steel inventories are believed to be excessive, and one steel economist expects steel consumers will begin to liquidate stocks this quarter and continue well into 1980.
While inflation continues at a strong pace in October, the median forecast of the Fourth District Round Table economists shows a decline in the GNP implicit price deflator from a 9.3% annual rate in the fourth quarter of 1979 to a 8.0% annual rate in the fourth quarter of 1980. One bank economist believes that interest rates and inflation are at secular peaks. Several economists point to somewhat larger productivity gains in 1980 to help offset increases in labor costs. An agricultural economist expects food price increases to slow in the first half of 1980, assuming no supply constraints, but to rise sharply by the end of the year. Several economists expect oil prices to rise sharply again in 1980, as a higher proportion of world supplies is shifted to the spot market. A housing slowdown is generally expected to provide relief for the home ownership component of the CPI in 1980.
Housing prospects have been scaled down as a result of October changes in policy actions. While several S&Ls in Ohio report little change in lending policy other than higher mortgage lending rates, the effect of credit rationing by price has substantially cut the number of low downpayment loans and eliminated many potential buyers from the market. In western Pennsylvania, many S&Ls apparently curtailed lending. Although most S&Ls are expected to be able to honor commitments already on the books, one S&L economist expressed concern about the shift of S&Ls back to short-term markets for funds which could become costly in the near future and could create serious roll-over problems. Still, several S&L officials report that every attempt is being made to continue lending activity. Housing starts, according to a FHLB economist in this District, are still expected to reach their earliest forecasted level of 1.8 million in 1979 despite the latest surge in mortgage rates. However, starts may fall to 1.3 or 1.5 million units in 1980, as net outflows of deposits restrict the availability of funds to S&Ls. If the market is threatened by such steep declines, one S&L economist expects FHLB and other housing agencies to institute programs that will support an additional 0.3 million starts in 1980.
District banks apparently have tightened lending activity, especially among consumer and C&I loans. One bank economist states that large firms so far are unaffected by high interest rates and some are taking advantage of rates by being net suppliers of funds. However, middle-sized firms will be in serious trouble if high rates continue for 6 to 9 months. Two large banks note a decline in C&I loans, which may be the result of anticipatory borrowing in previous months. According to a capital goods producer, banks have showed greater reluctance since October 6 to buy secured paper of small job shops, which is making it difficult to finance machinery sales. Auto dealers complain that banks have tightened credit terms and have sharply curtailed lines of credit. Finally, some banks report that the rejection rate for consumer loan applications has risen since early October and new borrowers without much credit experience must now obtain co-signers.