Beige Book Report: Cleveland
August 5, 1980
The sharpness of the second quarter decline in real GNP has not altered the outlook among most Fourth District respondents that the recession will bottom out in the late fall and a sluggish recovery will begin in the fourth quarter. The increase in PCE during June is generally viewed as a sign that a trough for some types of consumer spending has past, but spending patterns may be irregular until early next spring. Residential construction appears also to have reached a trough in the District, but builders are still discouraged by high mortgage rates. The business sector has begun to feel the impact of the consumer-centered recession beyond the already weak steel-rubber-glass industries. Respondents expect a sharp slowing in the pace of inflation during the next quarter, but see little abatement in the underlying rate of inflation. Layoffs, especially in the steel industry, appear to have peaked, with unemployment rates through June that were still below 1973-1975 levels.
The current recession is in the process of shifting from the consumer and construction sectors to the business sector, according to several officials in the Fourth District. However, the need for long-delayed capital expansion and continued auto retooling should provide some underlying strength to the business sector. Despite the sharpness of last month's decline in real GNP, several business economists are more confident that the recovery will begin in the fourth quarter than they were early this summer. Although the recovery is generally expected to be sluggish, an auto parts supplier asserts that new car models will provide stimulus needed for a slow recovery. A steel economist cites the need to rebuild steel inventories by the fourth quarter, along with renewed orders from the auto industry, as providing additional strength to the economy. According to a bank economist, however, the current level of consumer debt, along with job insecurity and scheduled increases in social security taxes in 1981, will prevent a strong rebound in consumer spending, especially for housing and appliances, until next spring.
Several consumer goods producers and retailers believe that the strength of the recovery in retail sales remains uncertain, but are more confident that the trough in real PCE is past. Some believe, however, that further declines in furniture, appliances, and housekeeping goods (such as paper products because of their soaring prices) are likely at least until Christmas. A major appliance producer reports that demand from dealers has been a little better than expected, partly because housing starts did not decline as much as expected and partly because hot weather induced sales of refrigerators and air conditioners. He expects the contraction in production and inventories of major appliances to end no later than next month. A supplier of packaging materials notes that nondurable goods and some durable goods, such as color TVs have held up better- than-expected. An official for a major department store chain expects a 1-2% (annual rate) increase in real PCE during the fourth quarter as auto sales strengthen, but expects a mild recovery in real PCE because of continued high inflation.
Record low levels in mortgage commitments in recent months suggest to several S&L officials that residential construction in the District may have reached a trough. Although sufficient funds are available to meet loan demand, consumers are still unwilling to accept current mortgage rates. A bank economists believes that a rate below 11% is required to produce a significant improvement in home buying. An S&L official notes that one home builder has been unable to attract customers with a 9.75% mortgage rate. An area banker expects construction activity to be limited to completion of homes in progress, with virtually no speculative building. Mortgage rates, according to an economist with a regional FHLB in this District, have stabilized between 11-12%. However, some S&Ls have raised their rates slightly and more are expected to adjust their rates upward if demand rises much during the summer season.
The business sector, especially capital goods, has begun to soften. Despite a five month backlog, a small machine tool producer reports new orders down 30% from year-ago levels and expects at least three more months of downturn. A producer of highway and nonresidential construction materials states that new orders in June were down 10% from year-ago levels and backlogs were 13% below last year. However, the declines seem now to be leveling off as the company moves into its peak sales period. An official for an industrial construction company notes that capital goods typically lag the business cycle, but the sharpness of the declines in April and May suggests the lags may shorten in this recession.
New orders for steel probably bottomed out in May, according to a steel economist, and are now rising irregularly toward consumption, which has been weakening. Steel consumption should stabilize when an upturn begins in automotive production, probably in the fourth quarter.
The consumer price index is expected to moderate to as low as 8% by year-end, but several respondents expect accelerated inflation in 1981. An official for a major food store chain expects the July CPI to be discouraging because of food price increases, although August through October should be steady. Industrial prices will be held down by the severity of the recession and may help offset food price increases. An S&L official notes that increases in housing prices have slowed and some builders are offering rebates. Several business economists expect inflation to rise to 11-12% rates through 1981. Further increases in layoffs comparable to the second quarter are generally not expected. A spokesman for a steel company states that layoffs currently represent 30% of their work force that serves the auto industry and 10% for specialty steel. Layoffs continue in coal mining in southern Ohio where high sulfur steam coal is restricted by environment regulation, according to an area banker. Layoffs are also being affected by business closings among auto and real estate dealers, according to a bank official. However, a state labor market analyst reports that about 50% of unemployed workers in Ohio are receiving supplemental income. Unemployment rates among major District SMSAs ranged from 5.8% to 13.2% in May, but still average about a half percentage point below the highs in the 1974-1975 recession.