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Beige Book Report: Cleveland

January 28, 1981

Summary
The slowing of business activity in December and early January appears to be setting the pace for little growth in the first quarter of 1981 in the Fourth District. The unexpected strength of the economy in the fourth quarter of 1980 has led most respondents now to expect a flat first quarter. Steel continues to be an exception, with orders and shipments holding up surprisingly well. Real investment spending continues to decline, but may reach its trough in the first quarter of 1981. Consumer spending has weakened, despite a late surge in Christmas sales. Little activity in housing is reported, with some lenders raising mortgage rates to as much as l6 1/2% for an 80% loan.

Outlook
Unexpected strength last quarter has caused several respondents to back away from earlier predictions of a decline in real GNP during the first quarter of 1981. A resumption of inflation psychology following the removal of credit restraints and a lessening sensitivity to interest rates are often cited as reasons for the relatively strong performance in the fourth quarter. However, a bank economist also lists a substantial increase in federal spending and widespread optimism after the third quarter rebound as additional major factors. Several respondents expect "high" interest rates to contribute to first quarter flatness, but note that effects have been slower and less severe than in past periods of relatively high interest rates. A capital goods producer states that availability of credit has not been a problem as in past periods of tight money and believes that the shock of record high interest rates is wearing off. Respondents typically forecast fourth quarter 1980 to fourth quarter 1981 growth of 2% in real GNP and 10% in the implicit price deflator.

Steel
Steel shipments in January remain strong, according to an industry economist, although new orders are running well below December's rate.

However, January's orders are considerably better than expected for early 1981. Inventory adjustment remains the major source of strength, with steel consumers no longer trimming inventories, except perhaps for industrial machinery, and steel service centers continuing to build inventories. Steel consumption has held up better than expected, according to an industry economist, because the auto industry has not deferred or canceled orders. Orders from the auto industry were lean to begin with, but an industry economist expects deferrals to begin in February. The steel industry made profits in the fourth quarter of 1980 (in some cases, sufficient to offset year-to-date losses), according to one producer, and may make profits in the first quarter of 1981 if orders continue to hold up.

Capital Goods
Investment spending remains weak in January, although some sectors continue to show strength. A capital goods producer reports that their aerospace business is stronger than their capacity to produce and their petrochemical business is very strong with no prospect of slowing. However, orders for industrial equipment began softening in November and mobile off-road equipment is still off over 50% from the latest peak. High interest rates may be a cause of the softening, especially among suppliers to the auto industry, A durable goods producer states that, with the special boost from the locomotive and airlines industries, company orders in the fourth quarter of 1980 were equal to the fourth quarter of 1979 (in real terms). An economist for a machine tool producer notes some pickup in small cutting tools orders, which reverses a downward trend since early 1980 for the company. A bank economist expects a 3% real decline in total business investment in 1981, with some improvement beginning in the second half.

Consumer Spending
Retailers and producers of consumer goods are generally bearish over near-term spending prospects. Although retail sales surged during the closing days of the Christmas shopping season, an economist for a major department store chain does not view the improvement as a shift in consumer buying or attitudes, because the increased sales only compensated for earlier weaknesses. However, inventories are generally lean, because retailers have been cautious with order placement. Across-the-board declines for food stores, drinking and eating places, and department stores are reported by an economist for the consumer goods industry. Food price increases may drop from a 12% rate to 8% because of better-than- expected supplies for wheat, soybeans, beef, pork, and poultry. Auto sales have shown no improvement in recent weeks, according to an area auto dealer. An auto industry economist reports that small car sales are doing well, but expects overall sales to drop from an 8.8 million rate in the fourth quarter of 1980 to 8.6 million in the first quarter of 1981. A bank economist reports no pickup in overall consumer borrowing and notes that the lending rate on auto loans, at 14 to 15%, is too high to generate much demand.

Housing
Housing activity is more than seasonally weak, according to area realtors and mortgage lenders, but "high" mortgage rates have been less of a deterrent than expected. Because interest rates have been high for some time now, according to a bank economist, some buyers can no longer wait for more favorable borrowing rates. Innovative financing is also enabling buyers to accommodate to the higher rates. An area real estate dealer estimates that 60% of transactions in recent months have involved non-conventional mortgages. However, the dealer reports that January sales, which are usually double the December level, are currently running behind December's rate. An S&L official expects little improvement until the third quarter, if mortgage rates would drop to the 12 to 13% range.

The reason loan commitments have not fallen as much as expected, according to an economist with a regional FHLB in the District, is that S&Ls have been able to raise money and build new liquidity. NOW accounts particularly have attracted larger amounts of funds than expected. While some switching from passbook accounts has occurred, an S&L official reports that new money is being attracted. Despite offering less competitive terms than area S&Ls, a bank economist also notes a net increase in funds from NOW accounts.