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Beige Book Report: New York

May 18, 1983

The Second District economy continued to show evidence of recovery in recent weeks. Major retailers reported that consumer spending remained strong, and sales generally were above plans. The residential real estate market picked up further, but some slowdown in nonresidential construction was anticipated. The upswing in manufacturing spread to more areas, and firms in many industries were increasing hours and workforces. On the financial side, retail deposits at all classes of depository institutions have grown with the introduction of MMDAs and Super NOWs. The consensus among business leaders is that the economy will continue to improve.

Consumer Spending
Retailers continued to enjoy year-over-year sales gains over the past two months, despite some temporary weakness in early April. Business at most department stores was running ahead of their plans. One respondent did note, however, that promotional efforts ''light-years ahead of last year'' were necessary to coax shoppers into buying. Soft goods and electronics continued to be sources of strength. One merchant indicated that furniture began to pick up as well. Inventories remained at desired levels, with one store keeping them "aggressively heavy." The outlook varied by respondent. One discount chain was considering an upward revision in its sales goals, while another retailer felt that the general optimism about the economy was unfounded.

Construction and Real Estate Activity
The residential real estate market showed further improvement recently and respondents believe that an upswing is definitely underway. Both sales and starts showed healthy increases. Most of the growth was limited to high priced homes, however. Some contacts believe a further drop in mortgage rates is needed before low- and middle-priced homes will move. While no one foresees a boom, builders expressed a good deal of optimism about the next few months. The outlook for nonresidential construction remained cloudy. Brokers reported that the absorption of office space improved in recent weeks. A number of major leases were negotiated or signed in New York City and surrounding suburbs. But observers see the pace of construction slowing. With new space being completed and vacancy rates trending up, rents have been flat and landlord concessions more prevalent. Consequently, new projects are expected to be limited.

Business Activity
The onset of recovery in the manufacturing sector was confirmed by recent reports from business leaders around the District. Areas hit particularly hard by the recession finally noted signs of an upturn, and regions that had remained relatively healthy reported somewhat faster growth. The upswing in auto-related industries has continued. Furniture orders finally rebounded, leading one supplier to that industry to believe that recent signals could foreshadow one of his best years ever. As backlogs developed and delivery times lengthened, firms picked up production schedules. Shortened workweeks became much less common. While some more layoffs occurred, such diverse industries as autos, aluminum, and communications equipment were adding to their workforces.

Outlook
Business leaders are virtually unanimous in believing that the recovery has arrived. Although there is some disagreement concerning its strength, our contacts have become more confident that the upswing will be sustained. One respondent noted that while businessmen are still cautious, they are expressing as much enthusiasm about the future as he can remember. Another believes prospects for economic growth look good for the next two or three years. But one state labor official still fears that the recovery will be one of the slowest on record.

Financial Developments
Reflecting national trends, home mortgage rates offered at banks and thrifts in the Second District have fallen by as much as 5 percentage points since last summer. While some of the institutions contacted offer only variable rates on home mortgages, most of those that offer both fixed and variable rates report that a very high proportion of new mortgages (about 75 percent) have fixed rates. In part, this reflects a narrowing of the spreads between the fixed and variable rates. In addition, most said that at least 20% of the mortgages now being made represent refinancings wherein households prefer to substitute one fixed rate instrument for another.

Many of the banks and thrifts contacted said that they are selling the bulk of their new mortgages in the secondary market. One institution specified that it is now mainly selling the fixed rate mortgages and using MMDAs to fund the variable rate mortgages. All in all, the institutions appear aware of the potential for mismatching assets and liabilities resulting from the inflow of MMDAs.

Since the introduction of MMDAs and Super NOWs, all classes of depository institutions in the Second District have gained retail deposits. The commercial banks, however, were clearly the biggest gainers, in both dollar volume and market share. According to our estimates, between mid-November 1982 and mid-March 1983, Second District commercial banks raised their share of the retail deposit market by as much as 5 full percentage points, from 30 percent to 35 percent. By comparison, in the rest of the nation it appears that the commercial bank gains in retail market share were considerably smaller. Some New York banks have expressed concern about the need to replace funding sources as the market for money-center CDs shrinks along with money market mutual funds. Perhaps because of this concern, competition for MMDA money has been particularly keen in New York City, where the rates offered on these accounts have been consistently higher than the national average.

Financial Panel
This month we have comments from David Jones (Aubrey Lanston & Co.,), Donald Maude (Merrill Lynch) and Albert Wojnilower (First Boston Corp.). Their views of course are personal, not institutional.

Jones: The "critical mass" for economic recovery is now in place and the question now is whether the recovery will be moderate or brisk. The seeds of recovery were planted by a sharp decline in interest rates in the second half of last year. More recently, there has been a pick-up in demand in such interest-sensitive sectors as housing, autos, and other durable goods. In the improved economic climate, businesses cut their rate of inventory liquidation roughly in half in the first quarter of this year and some actual restocking may begin in the second quarter, thus further strengthening new orders, production, employment and income. The recovery is, however, likely to remain moderate and uneven through 1984. Serving to limit economic gains are likely to be abnormally high real rates reflecting the clash between recovery-related increases in consumer and business credit demands and excessive Federal borrowing demands arising from mounting structural deficits. Accordingly, the recovery is likely to stall from time to time as business spending on new plant and equipment remains depressed (both because of high real rates and a huge margin of unused capacity) and as U.S. exports continue weak (because of a strong dollar). All in all, real GNP might show gains of 5.0 percent in the second quarter, 2.0 percent in the third quarter and 4.0 percent in the fourth quarter. In 1984, the pattern might be 6.0 percent in the first quarter, 7.0 percent in the second quarter, 3.0 percent in the third quarter and 4.0 percent in the fourth quarter.

Maude: While progressing at an uneven pace, as is almost invariably the case in the early recovery phase, the present economic recovery should remain intact going into 1984 in an environment of restrained inflation and inflationary expectations. Presently, we envision a second half 1983 gain in real GNP of 5 percent and an annual rate of increase of 5.7 percent in the consumer price index. Under such conditions, private credit demands throughout the remainder of the year should remain sufficiently restrained to allow the Treasury to raise a projected 110-120 billion net new cash over the final two quarters of 1983 without much disruption to the financial markets on balance. However, even a controlled slow growth recovery runs the risk of being aborted as early as the first half of 1984 as rising private credit demands begin to clash with fiscal 1984 Treasury financing requirements exceeding $200 billion—potentially leading to a meaningful upward spike in interest rates. Indeed, even at present real interest rate levels, the sustainability of the recovery remains tenuous. However, monetary policy is once again perceived by the financial markets as credible and latitude for further accommodation in an interest rate sense presently exists.

Wojnilower: Domestic business contacts suggest that the economic recovery is broadening somewhat and that confidence for the longer pull has increased materially. At the same time, the nearly explosive attitude displayed previously by executives in some segments of the department store, steel, and building materials industries has sobered, as what in their perception were initially extraordinary sales gains have slowed considerably. In the security markets large amounts of new issues of all types continue to be placed. Demand by foreign investors is enormous but a torrential reversal well might ensue if policies to weaken the dollar were officially adopted. During a visit to Europe last week, I gathered the impression that the reported business pickup on the continent may be more an improvement in sentiment than in performance. In France, of course, a sharp setback in business is anticipated. In the United Kingdom, Mrs. Thatcher's reelection is taken virtually for granted and people are quite sure that business is rebounding.