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Beige Book Report: New York

December 16, 1981

Economic activity remained sluggish in the Second District during November, with some further softening evident. Retail activity unexpectedly slowed before Thanksgiving but has since recovered somewhat. Poor conditions persisted in manufacturing and additional weakening in capital goods orders was observed. Residential construction continued to be depressed, but a falloff in nonresidential construction contracts was believed to be temporary. Business economists now expect sizable declines in real GNP during the fourth quarter and no real pickup until the second quarter or half of 1982. On the financial side, mergers, acquisitions, and cash shortages pushed up the demand for business loans.

Consumer Spending
Retail activity virtually stopped growing in early November, with some department stores experiencing a drop in business. The pace has quickened since Thanksgiving, but most retailers are still slightly below plan. Since the bulk of Christmas buying has been occurring later in the season in recent years, merchants are hopeful that the pickup in sales will continue, producing a reasonably good holiday season overall. Many stores are depending on heavy promotions and price markdowns to spur sales. All respondents expressed serious concern about January and beyond.

Manufacturing Activity
Manufacturing activity remained depressed during November, with further weakening reported by some firms. After appearing to bottom out during September and October, new orders received by capital goods producers declined again. Although one capital goods supplier maintained output by depleting its backlog, all others cut production levels. Workforces have been reduced through layoffs or attrition. One establishment, however, preferred to retain highly skilled employees and to add the excess output to its inventories. Capital spending by many of these producers of durable equipment has been lowered, and, in one instance, stopped altogether.

Other manufacturers also experienced flat or slightly lower sales. Even the previously strong demand for data processing equipment has slipped. The only increase in business was reported by a company whose aerospace division received a large quantity of new defense contracts. Businesses are adjusting to the bleak situation with stringent cost controls, the elimination of internal inefficiencies, and in one case, a restructuring of pricing policies to curtail price cutting competition.

Construction and Home Sales
Construction activity continues to be very low in the residential sector and strong in the nonresidential sector. Home sales are down from October's poor level. High financing costs are blamed for the sluggish activity in the residential area. Recent declines in interest rates have not yet improved conditions. Any gains that do occur are expected to be modest and temporary. As for nonresidential construction, a drop in the value of contracts let in New York City is viewed as only temporary. Major projects such as Battery Park City are scheduled to begin soon, and the new work should be sufficient to sustain a high rate of office construction activity.

Economic Outlook
Business economists have revised their forecasts of economic growth sharply downward. A dismal fourth quarter is expected to yield a real GNP decline as large as 7 percent, followed by negligible growth at best during the first quarter of 1982. Manufacturers generally agree with this outlook, anticipating no significant upswing in business until the second quarter or later. Overall growth for next year is estimated to be one percent or lower by all but one economist. The prime rate is projected to average 14 percent during the coming year. The 1982 inflation outlook is unchanged from the 8 to 9 percent level forecast last month.

Financial Developments
Lending officers at commercial banks report that there have been moderate to significant increases in demands for business loans during recent weeks. Mergers and acquisitions were an important source of the increased demand, as was the greater-than-expected deterioration of corporate cash flows. A related source of the strength in loan demands has been the need to finance unintended inventory accumulations. While demands for bank loans have been strong, the growth of commercial paper outstanding has been sluggish. Although rates on commercial paper are appreciably below the posted prime rate, bank borrowing demands have remained strong because of the flexibility of such borrowing arrangements and the widespread use of below-prime lending facilities.

Financial Panel
This month we have comments from Francis Schott (Equitable Life Assurance), Robert Stone (Irving Trust) and Albert Wojnilower (First Boston Corporation):

Schott: Institutional money flows are beginning to improve under the influence of lower interest rates. But demand for long-term funds is very heavy, partly in order to improve liquidity ratios and partly to finance investment projects, especially in energy. Therefore, long rates may stay relatively high.

Financial markets are less concerned with fiscal 82 Federal deficit than with the grim prospects for fiscal 83 and 84. Money growth targets and fiscal prospects are viewed as clashing, with the private sector the likely victim.

Stone: By letting borrowings get so low the Fed has effectively severed the connection between the discount rate and the Federal funds rate. The funds rate will nevertheless hold up in December, if only because of the seasonal strength in short term credit demands. But when these demands subside in January, for seasonal and perhaps for cyclical reasons as well, short term rates could fall sharply. Such a drop in rates could well be followed by a surge in the aggregates at what might be a most unpropitious time.

Recent increases in aggregates should push required reserves up, and I believe the Fed should respond by letting enough borrowings emerge to reestablish the connection between the discount rate and the funds rate. "Enough" borrowing for this purpose are $500-600 million exclusive of seasonal borrowings and extended credit. Once that connection is reestablished the Fed can again do what it did so effectively over the past two or three months—lead the rate structure downward at its own pace by periodic reductions in the discount rate.

By this means the Fed is most likely to achieve the objective of lowering interest rates while minimizing the risk of a serious overshoot in the aggregate.

Wojnilower: Such indications as I am able to gather from business contacts support the view that the business decline may soon slow materially. This prospect, coupled with apparent acceleration of monetary growth, is roiling the bond market. Severe securities market repercussions are to be expected if average Federal funds rates were to rise.