Beige Book Report: Cleveland
July 1, 1980
Business activity in the Fourth District continued to decline sharply in June as the recession begins to affect business spending. Most respondents expect the recession to bottom out late this year, followed by a sluggish recovery in early 1981. The summer months will likely be marked by inventory liquidation. The worst of the decline in consumer spending appears over, but new car sales are expected to remain relatively flat until the introduction of new fuel-efficient models later this year. Loan demand, according to District bankers, continues to be weak across-the-board. Housing remains depressed, despite significant reductions in mortgage rates and improved deposit flows into S&Ls.
Economists who attended the Fourth District Economists Round Table meeting held at this Bank on June 13 have revised their forecasts of real GNP downward since the March meeting. Although virtually all of the 27 economists who attended the meeting forecast a sharp decline, only four expected an equally sharp recovery. The median forecast of the group shows a 7.3% annual rate of decline in real GNP in the second quarter, 4.3% decline in the third quarter, 1.6% decline in the fourth quarter, and a recovery at annual rates of 1.3% and 4.7% in the first and second quarters of 1981, respectively. Next quarter's anticipated reduction in real GNP is largely associated with a decline in inventory investment and a further contraction in residential construction. However, a higher level of consumer spending from the second quarter is anticipated.
Generally, most officials believe capital spending plans for 1980 are unlikely to be adjusted downward unless cash flow weakens more than is now expected. Although several capital goods producers report no adjustment in spending plans, there is concern that a cash flow squeeze could result in some cutbacks in the period ahead. However, some firms directly affected by weakness in consumer spending have already begun to cut back capital spending because of poor operating rates and a poor profit outlook. A rubber and chemical producer reports that capital spending for 1980 is being cut to $200 million from $300 million because of poor earnings and projected sluggish growth for rubber products. A steel producer has announced another postponement of a $280 million project for its Ohio facility because of a poor profit outlook and is planning to trim a $400 million capital spending program for 1980 by $50 to $100 million.
Some liquidation of inventories is expected to get underway following a sudden step-up in inventory accumulation in recent months. Generally, most respondents believe that inventories are not nearly as out of line with desired levels as they were in 1974-1975. General merchandise inventories rose sharply between March and May, according to a major retailer, and inventories are now at least 6% higher than desired and will be promptly liquidated during the summer months. Adjustment of soft-goods inventories is expected to be completed by the end of summer, but will take longer for furniture and appliances. Passenger tire stocks are still considered lean at the plant and distributor level. One producer has offered dealer incentives to build stocks, but dealers have preferred to keep inventories low until sales pick up. Inventories of steel mill products are judged to be excessive and are already being worked down by capital goods as well as consumer goods users of steel. Energy stocks, especially petroleum products and coal, are judged to be more than ample. The buildup in crude oil and gasoline stocks until recent months was planned because of uncertainties in world oil markets, but large stocks will contribute to an easing in utilization rates to the low 70s through the balance of 1980.
Consumer spending appears to have bottomed out. Sales of small appliances continue to show surprising strength in recent months, according to a consumer durables producer, while declines in major appliances have been quite sharp. Nondurable goods are experiencing a return to more traditional spending patterns, with a greater willingness among consumers to spend without the influence of price hedging. Although auto sales have remained very weak throughout June, a producer and some major auto dealers report that June sales will be higher than May. Recent improvements are partly attributed to lower installment lending rates on direct auto loans, but lending rates throughout the District have not fallen much from highs in March. Heavy discounting, except for slow-moving standard-size cars, have been avoided, according to an area dealer, because of the low volume of sales generally. Several auto dealers remark that sales will be flat until new model cars appear in the fall. Otherwise, recovery in sales will be delayed until spring.
Demand for consumer and industrial loans remains very weak. Several bankers report that consumer credit demand continues to decline virtually across the board, despite some easing of credit terms. Installment rates have not been lowered very much thus far. One area banker states that lower auto loan rates could not be justified because they would not induce additional demand to offset the profit squeeze, and alternative investments offer better returns than auto loans. A Pennsylvania banker states that interest rates on consumer loans never rose much because of usury laws in that state, and when they were finally modified, demand had already begun to weaken. Although some borrowing to finance inventory may be occurring, a banker expects C&I loans to remain soft for the rest of the year, as large corporations continue to issue commercial paper and small businesses fail to qualify for bank credit.
Banks and S&Ls in the District uniformly report strong growth in savings and time deposits in June. With mortgage loan rates in the range of 11% to 13%, borrower demand has shown little improvement. A large S&L in Cleveland recently introduced a 9 3/4% mortgage rate for a 1-year rollover mortgage. Lenders note an increase in inquiries in response to reduced mortgage rates, but not much pickup in commitments and loans, nor do they generally expect a significant pickup for the time being. However, one S&L official reports loans are currently in a $6 to $8 million range compared with a more typical $25 to $30 million range, but hopes the recent pickup in inquiries and applications will lead to a $15 to $20 million loan month in the near future. An economist with a regional FHLB in this District asserts that some lenders are reluctant to make commitments and loans, and instead, they choose to rebuild liquidity and repay advances from the FHLB. Apparently, some associations are intent on reporting a profit as soon as possible following a disastrous first quarter and perhaps first half.