April 15, 1980
Respondents in the Fourth District now expect a somewhat deeper recession than they did in early March as signs of recession are spreading beyond residential construction. Business spending remains strong, but fixed investment is expected to decline if interest rates remain high. Although it is too early to tell how consumer attitudes on spending have been affected by the March 14 credit restraints, most respondents believe retail sales are in a contractionary phase. Bankers generally confirm that loan demand remains strong for business, but loan demand has declined for consumers because of credit constraints. Several banks and S&Ls are withdrawing from the mortgage market until short-term interest rates stabilize or decline. Inflation appears to be on the verge of a steady decline over the next several months, although the underlying inflation rate is believed to remain unchanged at about 10%.
Respondents associated with consumer spending and housing believe a recession is now underway. Several economists who attended the Fourth District Round Table on March 7 have lowered their real GNP forecasts because of higher interest rates and tightening credit conditions. Instead of a mild 1.0% peak-to-trough decline during the second and third quarters that they projected in early March, they now expect a decline between 2.5% and 3.0%. Although virtually all the respondents believe that interest rates have peaked, economic activity next quarter is expected to show the sharpest decline as business spending weakens along with the decline in consumer spending. However, a fourth quarter pick-up in real GNP is foreseen by most respondents as consumer spending strengthens in response to lower interest rates and expected tax cuts. Virtually all of the respondents expect a sluggish recovery.
Prospects that business spending will be relatively unaffected by the recession seem to be fading. Because long lead times are required, fixed investment programs already underway are unlikely to be cut, according to one capital-goods producer, even if new equipment is no longer needed for the near-term. However, rising interest rates and weakening cash flow positions will cause cancellation of many short-term spending programs. An economist for the auto industry states that fuel efficiency laws will prevent capital spending cutbacks that might normally have occurred in the industry. An economist for the machine tool industry reports that new orders are beginning to slow, although some businesses may be waiting to see if interest rates fall before placing their orders. Although a mild inventory liquidation may still occur in the second and third quarters, most respondents report that inventories are under control. Even auto inventories are under better control now than recently. However, a consumer-durables producer is concerned that small businesses are being squeezed by credit constraints and expects a rising incidence of returned goods and of bankruptcies.
Although some softening in PCE was expected, credit restraints will make financing of durables goods by consumers more difficult. March sales of department store type goods slowed sharply from the first two months of 1980. An economist for a major department store chain reports a 7.5-8.0% year-over-year gain in 'March compared to much larger gains in the previous two months. In real terms, sales increases did not match price increases (about 8%) for department store type goods for the first time since 1975. Also, the auto sales slump in recent weeks was widely attributed to the end of rebate programs. Most banks in the District will be eliminating free credit on credit cards by mid-year, while department stores will be increasing minimum monthly payments. Because credit in real terms has been sliding for the past year and a half and installment credit in nominal terms slowed even before the March 14 controls, one economist in the retail industry believes that controls are untimely and will worsen consumer spending prospects. A bank economist believes that the personal saving rate will rise shortly because consumers are faced with a cash flow squeeze and are becoming concerned about their ability to service debt.
Several bankers indicate that loan demand is consistent with the current pattern of business and consumer spending. C&I loans are very strong, although the rate of growth has plateaued. One bank economist expressed concern about the financial position of some borrowers, but does not expect heavy business borrowing to cause any unusual problems during the recession. Consumer installment credit has dropped sharply. Consumer loan demand, according to a District banker, has declined because consumers, concerned about the economy and higher interest payments, have reduced their spending and because banks, watching their profits decline, are discouraging some consumer loans that are currently unprofitable. However, a bank economist notes that customers are accumulating balances on their credit cards and are now paying the minimum balance more than ever before. Most bankers and retailers contacted will eliminate free credit, but one retailer is reluctant because 60% of his sales are based on credit.
Mortgage lending has dropped dramatically in the last few weeks. One S&L official reports that five rate increases since March 3 have raised his mortgage rates from 14% to over 17%. Several S&Ls report continued weak deposit flows, although six month money market certificates still attract funds. Jumbo CDs are still required to meet past commitments. Still, pent-up demand remains high, according to an official in the housing industry, and a drop in mortgage rates later in the year could bring many buyers back into the market. Currently, for new construction, only builders having close ties with S&Ls can borrow, according to one bank economist.
The rate of inflation is widely expected to slacken in the next few months because of a peaking in mortgage rates and deceleration in energy price increases. The underlying rate of inflation, according to a steel economist, is still around 10%, but weights attached to mortgage rates over-emphasize the component in the CPI. Declining rates, perhaps 700 basis points by the end of the year, will reverse the process and reduce the pace of inflation by as much as two percentage points. Along with an easing in energy costs and food prices, several economists forecast consumer prices will increase between 10 and 11% by the end of 1980.