June 25, 1985
Summary
Observers of economic developments in the Seventh District generally
view the current situation and outlook with caution. No recession is
anticipated, but neither does an upturn appear in prospect from the
sluggish overall trend, and weakening manufacturing sector, of
recent months. Construction or office buildings and stores,
rehabilitation of older structures, and highway and bridge work
continue vigorous. Residential sales and building are rising in
response to lower mortgage interest rates. Auto and truck sales are
at high levels, and a large rise in auto output over last year is
planned for the third quarter. Major home appliance sales are at
record levels, but the recent rise is centered in microwave ovens,
many imported. Other areas of consumer spending for goods have
flattened or declined. Consumer debt levels are high, and
delinquencies are up significantly for some lenders. Manufacturing
jobs in the Seventh District have declined since January, adjusted
for seasonal patterns. Employers trying to force down labor costs in
air transport, auto production, trucking, and food retailing have
been met with work stoppages and costly litigation. Most District
capital goods producers have experienced only limited recovery, at
best, from reduced operating rates of 1982. Some lines, including
heavy construction equipment, railcars, and farm machinery, have
remained at very low levels, with numerous plant closings. Steel
orders are rising, chiefly due to auto industry buying, but demand
and pricing remain short of satisfactory levels, and vigorous cost
cutting continues. The recent weakening in personal computers and
semiconductors has had relatively little impact in this region.
Continued declines in agricultural commodity prices have added to
strains on farmers, suppliers, and rural communities. Strains on
farm lenders apparently have also intensified. Business executives
are studying and commenting on the Administration's tax reform plan,
with mixed reactions.
Tax Plan Reduction
Most District executives recognize the merits of the
Administration's goal of simplifying the federal income tax system
and reducing marginal rates. However, equipment producers strongly
oppose elimination of the investment tax credit, and many are
concerned about the effect on future cash flow of tighter
depreciation rules and "recapture" of so-called windfalls from past
accelerated depreciation. Builders decry the proposal to end tax
credits on renovations of older commercial structures, which have
been accounting for a substantial share of current construction
activity. There is also concern over the proposed requirement that
equipment and buildings must be in service on January 1, 1986, to
qualify for existing incentives. However, many believe that the
abrupt cutoff will be modified to permit a more gradual transition.
Home builders will strongly oppose elimination of deductibility on
personal returns of state and local taxes and interest on second
homes. Attitudes of state and local governments on deductibility of
taxes are mixed. In Illinois, there is sentiment that existing rules
comprise a subsidy to other states with heavier taxes. Despite these
apprehensions, the proposed tax legislation does not play a large
role in projections of demand or profits for the remainder of 1985.
Import Competition
Heavy import competition, attributable largely to the strong dollar
and lower labor costs abroad, is gradually squeezing down
manufacturing activity in the District in a broad variety of
industries. It is widely believed that the growth of imports is
understated because of lags in "documentation" at ports of entry.
Meanwhile, more and more operations are being shifted abroad--to
Europe, Latin America (especially Mexico), and the Far East.
Examples include electrical apparatus, auto parts, household
appliances, and farm and construction equipment. Pressures to seek
lower costs abroad are so strong that changes in tax laws, or even
significant weakening of the dollar, are unlikely to arrest the
trend.
Capital Goods
Seventh District capital equipment producers continue to be battered
by the strong dollar. A more sluggish domestic economy apparently
also has cut growth of capital spending plans and reduced orders.
Demand is generally weak for various types of heavy capital
equipment. Railcar orders are down from very low levels last year.
Motor Vehicles
Sales of cars and trucks continued strong through May, helped by
cut-rate financing, dealer incentive programs, and easing of
shortages. However, inventories of some models are still tight.
Planned third quarter auto production would be highest for the
quarter since 1977, and 16 percent above year ago. Truck sales in
May were highest ever for the month. Sales of medium and heavy
trucks are expected to rise 3-5 percent in 1985, with only small
gains in the second half. Truck trailer orders and shipments have
fallen substantially, following the surge in production of larger
and tandem trailers last year in response to changed Federal
regulations. A small Midwestern auto producer has given notice that
it plans to end car production in the U.S. unless labor agrees to
sizable concessions.
Steel
Steel production at Chicago area mills has declined somewhat since
spring, but output has increased in the Detroit area. Third quarter
bookings indicate a smaller than seasonal decline in output, mainly
because of auto industry needs. Construction fabricators' backlogs
are rising, especially for bridges and commercial buildings. Demand
for steel remains very weak for heavy industrial projects, oil and
gas, and farm and construction equipment. With continued losses,
steel companies are still drastically cutting costs, eliminating
marginal facilities and workers and contracting out additional
functions.
Construction
Office and retail construction, renovation, and highway work
continue vigorous in the Chicago area. The market for large blocks
of office space in and near the Loop is tight, but a substantial
amount of space is available in smaller blocks. A large volume of
new space will hit the market in Chicago next year and may cause a
serious glut. A record volume of highway contracts will be let by
the State of Illinois in June. No shortages of materials are
anticipated.
Mortgage Rates
Lower interest rates are boosting housing sales and construction.
Residential building has strengthened, with midrise suburban rental
apartments up strongly, perhaps in part to "grandfather" current tax
treatment. Home resales have also improved. Fixed-rate 30-year
mortgages are being quoted by Chicago area lenders at contract rates
as low as 11.5 percent. First-year rates on adjustable rate loans
are quoted by numerous lenders at rates under 10 percent, with some
being offered at 9 percent or less. Lower rates are encouraging a
shift toward fixed-rate loans.
Consumer Spending
Major chain stores in the Seventh District report weaker sales
growth in recent months, for both durables and nondurables.
Distribution of delayed tax refunds did not discernibly boost
spending, according to a large retailer. Consumer buying on credit
has been heavy, and delinquencies have been rising. With inventories
somewhat heavy, retailers have been scaling back orders. Total
shipments of major home appliances have been at an all-time high.
Agriculture
Low commodity prices continue to plague District corn and soybean
farmers. Average farm commodity prices fell further in May, to 11
percent below a year earlier and lowest for the month since 1980.
Unexpected weakness in livestock prices has paced the decline in
recent months. Hog prices are down 14 percent from a year ago, in
part reflecting large increases in competing supplies of poultry and
escalating imports from Canada. Crop plantings progressed well ahead
of normal. Early plantings usually enhance yield prospects. Without
a large rise in crop exports, not now anticipated, a big harvest
would add to stocks and hold prices at support levels.
Recent developments are reportedly adding to the pressure on the cooperative Farm Credit System. Stock requirements of several PCAs in Iowa were frozen. In addition, the Omaha FLB raised its farm mortgage rates 75 basis points. These developments reportedly triggered a "flight" of good borrowers from PCAs and FLBs to other lenders. In some cases, the flight has been encouraged by heavy advertising of lower rate loans on the part of competitive lenders.