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Beige Book Report: Chicago

December 5, 1990

Summary
Economic activity in the Seventh District slowed moderately in October and early November, although several contacts reported that some sectors were holding firm. Retailing sources indicated that personal consumption spending has begun to show the effects of a decline in consumer confidence, and it is difficult to detect previously available signs of relative strength in spending in the District. A slowdown in orders from auto dealers prompted Big Three automakers to reduce assembly plans for the fourth quarter, affecting a number of District production facilities. Overall manufacturing activity is mixed, however, with strength in shipments in several key sectors accompanied by some weakening in orders in other sectors. Large District banks generally continued to tighten lending standards, especially for commercial real estate development. While many projects continue to move ahead, a number of contacts expressed growing concern about future construction activity.

Consumer Spending
Consumer confidence fell more sharply from July to October than in any three month period in the last 44 years, including the 1973-74 oil embargo period, according to the University of Michigan's Index of Consumer Sentiment. Several contacts in the retail sector stated that this decline has begun to impact consumer spending. A national department store chain reported that the weakness in comparable- store sales that developed in October continued into early November. Results in several Midwestern markets were somewhat better than in the nation as a whole, although sales still declined (year-over- year) in October and early November. Store traffic has slowed, according to this contact, but the average expenditure per customer is holding up. A fast-growing specialty retail chain based in the District reported that sales growth in September and October dropped more sharply than in past experience. Sales in the company's big- ticket durable goods category fell sharply from a year ago. Recent weakness in durable goods sales was also reported by a large department store chain, with October appliance sales in the Chicago metropolitan area declining somewhat less than in the nation as a whole. A large national discount store chain reported that the month of October ended stronger than it began, with good momentum continuing into November. This contact had reported declining year- over-year sales growth from June through September, a trend that reversed itself in October and early November. District sales growth lagged behind the company's national average, principally because of increased competition in the Midwestern market.

Auto Production
Auto production in the District faces a serious slowdown over the next several mouths. Slowing dealer orders have prompted Big Three automakers to reduce production schedules for the fourth quarter, and several auto industry analysts maintained that Big Three production cutbacks probably will be greater than those already announced. While income guarantees included in organized labor contracts may help cushion the impact on District consumer spending, one analyst noted that the employees of many regional suppliers to the industry do not enjoy such protection. Still, several automakers contended that current and expected conditions should not produce a slump in the auto sector comparable to those in previous recessionary periods. One industry spokesman argued that 1991 sales could be as high as in 1990 if the Middle East crisis is resolved soon.

Manufacturing
Overall manufacturing activity in the District is mixed. While other durable-goods sectors have weakened along with autos recently, machine tool orders in October were robust and steel production remained solid. A large District steel producer reported that October was a good month for the company's shipments. Order books for the industry are generally full for the fourth quarter. Steel orders for the first quarter of 1991 look normal, according to an industry economist, including orders from the auto industry. A major producer of capital goods in the District reported that nondefense machinery shipments in October grew slightly faster than for the year-to-date period. However, nondefense machinery orders declined in October, in contrast to relatively strong growth for the year-to- date period. The capital-goods market was characterized as showing "no widespread recessionary cratering," but concern was expressed about the near-term outlook. New weakness in orders is consistent with the results of October purchasing managers' surveys in Chicago and Indianapolis, both of which showed relatively sharp declines in the new orders component.

Slowing economies in Canada, Western Europe, and other foreign markets could affect a significant source of expected strength in the District's manufacturing sector. A large District producer of heavy equipment reported continued slowing in unit sales in October and early November in many of its important overseas markets, following the weakness that developed over the summer. Sales growth in Asia has continued at about the same pace recorded in the third quarter, however. A capital goods producer in the District reported solid increases in export sales (in current dollar amounts) in October, but noted continued weakness in some of its foreign subsidiaries' sales. Another large exporter in the District, which produces less cyclically sensitive goods, stated that unit sales volume overseas continued to expand in October and November.

Banking
The downturn in the U.S. commercial real estate market, the prospect of higher deposit insurance premiums, and bank regulatory concerns about capital adequacy have combined to tighten credit standards at large banks in the District. One bank economist stated that recent loan demand has been driven in part by greater customer concerns about the future supply of credit, which contributed to a recent surge in medium-term note issues. Several large District banks reported stricter standards on commercial and industrial loan applications by large borrowers, while a smaller number disclosed stricter standards for small and middle market firms. Approved lending generally (although not universally) bore higher spreads on loan rates over base rates, stricter covenants, decreased maximums for credit lines, and somewhat increased credit-line fees. District respondents generally reported tighter credit standards for construction and land development loans than for other types of loans. One large District lender stared that commercial mortgage loan foreclosures are "certain to exceed 1987 levels (the previous peak) in 1990."

Construction
While most construction projects that previously received financing continue to move ahead, commercial and multi-family residential construction have become generally acknowledged sources of weakness in the District economy. A large contractor in the District stated that occupancy and rental rates indicated that demand for new office building and hotel construction would probably be "falling rather sharply." Construction of retail stores and industrial structures has been relatively strong, but this contact believed that conditions would likely deteriorate in these areas as well. A large manufacturer of construction equipment reported that sales in the District were holding up relatively well. However, equipment customers were expressing reservations about future District construction activity, if conditions in the Northeast and the West Coast spread to the Midwest. A producer of construction materials reported greater declines in shipments for October than for the year-to-date, and noted that industry shipments in the District have begun to show declines comparable to those in the nation as a whole. Still, this source stated that Midwest construction activity is "not quite so bad" as in much of the rest of the country. A District manufacturer of capital goods used in construction reported that, after four months of deterioration in contract awards, order rates were just beginning to fall off. Reports of construction slowdowns are not universal, however, and development continues in many communities outside of major metropolitan areas in the District.