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Beige Book Report: Cleveland

January 24, 1990

District respondents believe that the regional and national economies are still on a growth path, even if real GNP may have shown little or no change, or perhaps declined, last quarter. Retailers expect sluggish first-half sales. Some respondents believe that the worst of the cutbacks in industrial production are about over, although softening continues in some high-tech industries. Further declines in interest rates are generally expected by spring.

The Economy
The predominant view of the Fourth District panel is that the real CNF growth rate last quarter ranged between zero and a 1 percent annual rate. They do not, however, believe that last quarter marks the beginning of a recession, and most still expect that slow growth in output this half will be followed by a revival in growth to about a 2.5 percent rate in the second half. One panelist still expects a mild recession this half.

Consumer Spending
Last quarter's apparent weakness in spending was led by a cutback in consumer spending, especially for new cars. Major retailers report that sales during the holiday season rose about 5% to 6% from a year earlier, but that the season was as promotional as 1987. They expect relatively sluggish sales in the first half of 1990, with strengthening beginning in the summer. Inventories are close to plans, but still a little high in view of uncertain sales prospects. A national retailer is planning to reduce inventories significantly through aggressive sales promotions and cutbacks in orders from suppliers over the next few months.

The tone of comments from auto dealers is guardedly optimistic. Sales of 1990 models are reported to be about "normal" to slightly below normal for this time of the model year, although foreign makes have been selling better than domestic cars. Some domestic dealers claim that price increases of Big Three cars average about 4% for 1990 models, partly because of added safety features mandated by law, but some foreign car dealers report no price increases for their cars. Incentives are again available on a full range of domestic cars, but some foreign car producers apparently are offering dealer incentives that they expect are sufficient to close sales. Domestic car dealers report they have been cautious in orders for 1990 models in an effort to hold down floor-plan costs.

Manufacturing
Some manufacturers believe that the worst is over for cutbacks in output, although the extent of an anticipated recovery is uncertain. Orders for heavy-duty trucks in the last three months have revived from last summer's low, but the recovery is still well below the peak levels of 1988.

Auto production may be slashed to an annual rate of 4.5 million to 5.0 million units in January, probably the low for the year, because of excess stocks and an uncertain sales outlook. Production is expected to climb to about a 6 million annual rate in February and March, if sales respond to broadened incentives.

Steel production, which had been at virtual capacity until last summer, has been cut to about 80% of capacity. A major producer reports that orders are beginning to pick up across-the-board for first-quarter delivery, and another expects that production will hold at about the level of last quarter through 1990. Lower steel consumption, led by weakness in auto output, rising imports, and inventory liquidation that will carry at least through the next few quarters, are expected to cause shipments to fall several percent from last year. Lower volume and further declines in steel prices will reduce profitability from last year. Capital spending, however, is expected to increase again because of the need for more efficient equipment. A smaller steel producer has cut back operations to about 70% of capacity because of reduced auto schedules and inventory correction.

Orders for small electric motors and equipment last month and for the fourth quarter were stronger than expected by some producers, and orders in January continue better-than-expected from a variety of markets. Weakness is centered in automotive and nonferrous industries. A larger increase in capital spending this year than last is being planned because of the need for additional capacity to accommodate the next peak.

Ball bearing orders have eased from the peak in 1989:IIIQ when the industry was confronted with long lead times, capacity shortages, and double orders. High inventories are now being liquidated, but the recent order level is still higher than a year earlier. Plans call for a larger increase in capital spending in 1990 than in 1989 for cost and quality improvement.

Some high-tech producers expect further cutbacks in orders and output this year from last. Communication equipment is expected to soften further this quarter before reviving next quarter. Softness in computer machinery, automotive and defense industries has slowed growth of semiconductor demand, although orders in December spurted.

Financial Developments
The recent reduction in the prime rate to 10% is expected to be followed by another one-half point reduction, possibly by spring, according to some bank economists. The latest reduction in interest rates, however, is not expected to stimulate much demand for loans, which have been sluggish for the past several months. Fixed-rate mortgages on 30-year loans are common at rates of about 9.5%, and realtors and lenders are cautiously optimistic over the near-term outlook for housing.