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Beige Book Report: New York

September 9, 1980

Business activity in the Second District continued to be weak in August. Although several department stores reported gains spurred by back-to-school purchases, sales were soft at others, and merchants were uncertain about the outlook for sales in the coming months. Automobile purchases also remained slow. Dealers are expecting little improvement until mid-1981, despite the introduction of new models. Outside the consumer sector, capital spending plans are still being reassessed at some firms and new orders at capital goods producers continued flat. The backlog of unfilled orders at these companies, however, has forestalled layoffs. The respondents, for the most part, discounted the favorable economic signals recently, and generally agreed that the recession was not about to end. On the financial side, business loan demand, while remaining generally weak, has shown some signs of picking up. At the same time, many banks have increased the prime rate to 12 per cent in response to rising market rates. The tighter money market conditions have been felt in the mortgage market as well.

Consumer Spending
Consumer spending in the Second District was uneven during August. At both higher priced department stores and mass marketers, activity early in the month was stagnant. This weakness, however, was linked to the very hot weather rather than to the recession. Spurred by back-to-school purchases in the latter part of August, many department stores were able to compensate for the earlier weakness and ended the month with fairly strong year- over-year gains. As has been the case for the last couple of months, New York City stores outperformed their suburban branches, while in upstate New York, the opposite sales pattern prevailed with suburban stores reporting better sales than in the large cities. Although inventories at most stores were not burdensome, one large department store was still concerned over its level of stocks in light of the very uncertain sales outlook. This store preferred high stocks, however, to the possibility of losing sales when demand strengthens. In general, the outlook of most merchants was cautious and uncertain. But, on a more positive note, one retailer felt that continued caution in consumer spending now may well result in an exceptional Christmas season when many postponed purchases might be made.

Automobile sales in the Second District were also mixed, soft early in August but stronger towards the end of the month. Demand for smaller-sized used cars has held up well and truck sales were on par with last August. According to one respondent, however, this upturn will not be sustained because it largely stemmed from purchases which could no longer be postponed. High interest rates and the sizable downpayment currently being required for automobile loans continue to be major deterrents to sales particularly for lower and middle income customers. (In some cases, however, inventory shortages and slow deliveries are hampering sales, primarily for foreign cars.)

The Manufacturing Sector
Outside the consumer sector, little evidence of improvement has developed. New orders at capital goods producers are minimal although backlogs of unfilled orders are sufficient to prevent layoffs at present. Inventories at most manufacturers are very low and with liquidation continuing, according to one respondent, a pickup in economic activity may begin soon, albeit a very moderate one, as inventories are rebuilt. Nevertheless, one major steel manufacturer has revised downward its long-term capital spending plans and a "major review" of all plant and equipment spending is underway at a large producer of paper and related products. In addition, this producer may close certain marginal paper plants soon because it expects to lag the nation during the recovery just as it did in the downturn.

Economic Outlook
The economic outlook of most District respondents was rather pessimistic. The recent signs of an upturn were not considered sufficient to trigger a sustained, broadbased recovery this year. In particular, the housing sector is expected to remain weak for some time. Respondents were divided, however, in their forecasts of consumer behavior. Some felt that the current cautious attitude and higher saving rate were only temporary aberrations while others expect consumers to continue to restrain their spending in light of an anticipated renewal of strong inflationary pressures.

Financial Developments
On the financial side, business loan demand at large New York City banks remained soft, although a little stronger than in previous months. Senior loan officers attributed this weakness to the lack of major capital spending programs, little acquisition activity, and the limited need for inventory financing. Only in the apparel industry was the demand for inventory financing fairly heavy. Reflecting the increasing cost of funds throughout August, banks increased the prime rate to 12 per cent. Higher interest rates have had a noticeable impact on the mortgage market. Lending activity has tapered off as the rates on new commitments have been increased from 1 to as much as 2 1/4 percentage points.

Financial Panel
Starting this month we will have comments from several of a group of financial market experts. This month we have comments from Henry Kaufman (Salomon Brothers), James O'Leary (U.S. Trust Company) and Albert Wojnilower (First Boston).

Kaufman: The backup in interest rates will not prevent a fourth- quarter recovery in the economy, but it is slowing the reliquefaction of businesses. There are now two corporate bond calendars-a "highly likely" new volume and a "shadow" calendar which hinges on a 50-75 basis point decline in long-term interest rates. This decline, however, can only come about if short-term interest rates fall. Otherwise, long-term interest rates will be under some upward pressure. Corporate reliquefaction is also being retarded by the involuntary inventory accumulation, the fall in profits and the temporary oil glut. The first two factors are likely to be reversing in the period ahead.

O'Leary: I find almost a universal expectation that the basic inflation rate will not decline appreciably in the near term and that the odds are strong that the inflation rate will escalate again in 1981 and beyond. As a result of this expectation and the expectation about interest rates which follows, one cannot expect long-term institutional investors to behave as they have in past cycles. The authorities need more than ever to take the intensifying expectation of inflation into account.

Wojnilower: Notwithstanding some comments to the contrary, my own feeling is that the recession is ending. This view confirmed by many nonfinancial contacts. In financial markets widespread expectation of a double dip recession. Accordingly, despite rise in interest rates, lenders more aggressive in pushing out credit. Thus would anticipate surprises on the high side in business conditions. Ten percent inflation clearly imbedded in the economy, but not in the markets.