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Beige Book Report: San Francisco

August 10, 1983

In recent weeks, the recovery in Twelfth District economic activity has gained momentum, with nearly all manufacturing and mining industries experiencing some degree of improvement in orders. Consumer spending increased at an accelerated pace, widening year-to-year gains in retail sales. Western homebuilding activity also continued to pick up through June, in contrast to the national slowdown. In the manufacturing sector, even the capital goods industries are reporting increased demand. While the recovery appears to be extending into the third quarter, a slowdown in home sales in July suggests that the pace could slacken. Commercial and industrial lending at Twelfth District banks continues to be weak, but the weakness is due to firms' improved cash flow and access to the bond and equity markets. Moreover, although District banks have begun to experience a slight outflow from MMDAs, that movement has been offset by a shift into longer-term and higher yielding consumer certificates.

Consumer Spending
Respondents throughout the Twelfth District report that retail sales have been rising at an accelerated pace. Major department store chains in Southern California reported that sales rose sharply in June and ran nearly 17 percent above the year-earlier level. In the Pacific Northwest, sales at some major stores were up as much as 30 percent. Business apparently remained strong through July. Since competition for sales is extremely intense and prices are up only a few percentage points, most of the gain represents increased volume. Retailers report that inventories are low and they are not planning any significant buildup as long as the price increases realized on merchandise remain small relative to interest carrying costs. Sales of durable goods, including expensive items such as. furniture and appliances, are rising even faster than nondurables. Consumer credit outstanding is growing, but the delinquency rate is declining. Sales of automobiles have been rising far above year-earlier levels and would be greater if some models were more readily available.

Manufacturing and Mining
The recovery has now extended in varying degrees to nearly all Twelfth District manufacturing and mining industries, except those engaged in energy production. The important lumber industry, which was one of the first sectors to show improvement because of the turnaround in national homebuilding activity, continues to boost production and employment, despite some recent weakness in lumber prices. The aluminum, copper and other metal industries are raising their capacity utilization rates as orders continue to strengthen from such important metal consumers as the automobile, appliance., container and housing industries. Even the West's major capital goods producing industries—including those that manufacture machinery, electronic equipment, trucks and aircraft—are experiencing a modest pickup in orders. Not only has consumer and defense demand for these goods increased, but business demand has risen. Improved airline profitability is finally enabling the world's airlines to boost orders for commercial aircraft.

Construction and Real Estate
Through June, indicators of housing activity in the West were exceedingly strong. Regional housing starts continued to rise to a level more than double that of a year earlier, and permit activity pointed to still further gains in the months ahead. But in the last month as mortgage interest rates have risen, home sales are reported to have slowed. As yet, there are no signs of overbuilding. Developers have, been proceeding very cautiously, building mainly on a pre-sold basis and holding their speculative units to a minimum. But many respondents fear that even a modest further increase in mortgage rates, say 50 basis points, could cause a substantial decline in residential construction during the second half of 1983. Even with the recent increase in rates, they expect the average level of starts during the last six months to be moderately lower than the hectic first-half pace. They point out that the majority of the new units started have been in the lower-price category aimed at the first-time buyer and that the recent increase in conventional mortgage rates to nearly 14 percent will price a sizeable number of potential homebuyers out of the market. Some builders already are beginning to "buy down" mortgages once again to keep effective interest rates affordable. In the nonresidential construction sector, activity continues to lag behind the year-earlier pace as vacancy rates remain high for office and other commercial buildings. The rising level of permits issued points to increased spending in the months ahead however.

Agriculture
California farmers have been experiencing sharply declining prices for fruits and vegetables in the past two months as crops have been higher than had been predicted when flooding early in the year caused late plantings. Prices for these items are still above levels of a year ago, however, and California farmers are expected to experience a year-to-year increase in net income from fruits and vegetables. The heavy winter rains also have had a positive side effect in working down excess inventories of many tree crops at higher prices. California farmers also are expected to benefit greatly from the combined effects of the Federal payment-in-kind (PIK) program and the Midwestern drought in boosting prices for cotton and grains. The Federal government is having problems fulfilling its PIK inventory return obligation to California cotton growers, however, in that those farmers do not have sufficient cotton under loan to the government to compensate for the huge acreage taken out of production. Elsewhere throughout the District, smaller gains in net farm income are expected, except perhaps in Utah, where net income could be down because of recent flood damage to the farm sector.

Financial Institutions
Commercial and industrial lending at Twelfth District banks has shown continued weakness in recent weeks, following the typical pattern in the early stage of recovery. Banks attribute much of the weakness to improvement in sales and cash flow, which is reducing their need for bank financing. The inventory liquidation which has accompanied increased sales has reduced their need. for short-term bank borrowing, while weakness in capital spending continues to depress businesses' need for long-term bank financing. In addition, the improvement in bond and equity markets has given large firms the opportunity to turn to those sources for long-term capital. Banks in the region also have begun to experience their first outflows from MMDAs which had risen to over 21 percent of their total deposits. Since mid-June, both industrial and business MMDAs at District banks have shown slight declines. However, the slight outflow appears to have been offset by a shift into longer-term consumer certificates as depositor's attempt to lock in relatively attractive longer-term rates.