Beige Book Report: Cleveland
December 2, 2015
On balance, the economy in the Fourth District expanded at a modest pace since our last report. Factory output was stable. The housing market improved, with higher unit sales and higher prices. Nonresidential building contractors reported continued strong activity. Retailers, restaurateurs, and new-car dealerships saw higher revenues on a year-over-year basis. The demand for business and consumer credit moved slowly higher. Exploration in the Marcellus and Utica Shales declined; investment in midstream and downstream projects expanded. Freight volume trended lower.
Reports indicated a tightening in labor markets. Net gains in employment were seen in construction and banking. Staffing firms reported a pickup in the number of job openings, although many are temporary positions. Job placements were stable. Wage pressure is widespread, especially in higher-skilled jobs. Overall, input and finished-goods prices were steady.
Manufacturing
Demand for manufactured products was little changed over the period. Key factors tempering output include a strong dollar, a slowdown in the energy sector, and softness in some emerging market economies. That said, suppliers to the motor vehicle, construction, and aerospace and defense industries are seeing strong demand. Year-to-date auto production at District assembly plants through October increased 1 percent compared to the prior year's level. The steel industry continues to struggle against an array of headwinds such as the strength of the dollar; high levels of imports, particularly from China; and low demand from the domestic energy sector. One steel processor noted that weakness in the energy sector is expected to linger into 2016 and potentially 2017. Capacity utilization rates have contracted since our last report. A steel executive reported that his industry's utilization rate has fallen to 65 percent. Despite the downside risks, many of our contacts expect that business activity will expand during 2016.
Capital spending was largely allocated for maintenance projects and new equipment. Steel makers made budget cuts to control costs and preserve cash. Overall, input and finished-goods prices were steady. Exceptions were found in agricultural commodities and energy, where prices declined. Steel prices continued to fall. There is a growing apprehension that the current trend in steel prices could persist for the medium run and severely depress the domestic steel industry. A couple of reports indicated that manufacturers are cutting prices on select products to compete with foreign imports spawned by the strong dollar. On balance, manufacturing payrolls were stable. Difficulty finding high-skilled craft and professional workers is driving up wages in some job categories. An auto executive reported that he expects a general lifting of wages across the motor vehicle industry because of the recent UAW contract negotiations. We heard many comments about moderate to large increases in health insurance premiums.
Real Estate and Construction
Year-to-date sales through September of new and existing single-family homes rose almost 10 percent compared to those of the same time period in 2014. The average sales price increased by more than 4 percent. Higher prices for new homes were attributed to rising labor costs and, to a lesser extent, low spec-home inventory. Realtors reported that existing-home prices increased because of declining inventory and low interest rates. Several contacts noted that demand for remodeling services has risen appreciably. New-home contracts remain concentrated in the move-up price point categories. Downside risks cited by homebuilders include a potential rise in interest rates and a shortage of skilled labor. In the southern part of the District, a homebuilders association recently opened its own trade school as a means of filling the labor pipeline. Despite the risks, homebuilders are cautiously optimistic and expect that new-home sales will continue along recent seasonal trends.
Nonresidential contractors reported continued strong activity, with revenues rising above year-ago levels. A majority of our contacts saw an increase in the number of inquiries and backlogs over the period, but the pace of growth is not as robust as earlier in the year. Slower growth was attributed to softening in the manufacturing segment and seasonal factors. Demand remains strong in commercial building, multifamily housing, and higher education. Several of our contacts expect some slowing in the flow of projects going forward, citing a decline in the Architecture Billings Index as evidence. However, they see this slowing as a short-term event.
Capital spending by general contractors was mainly for maintenance projects and new equipment. Materials prices were stable other than for concrete, the price of which has been increasing over the past few months. Construction payrolls expanded at a modest pace over the period for field and office jobs. The construction industry remains challenged by a labor shortage, including laborers and skilled craftsmen. The end result is upward pressure on wages. We heard many comments about escalating healthcare insurance premiums during the renewal period, with an average year-over-year increase of 20 percent (median of 16 percent).
Consumer Spending
Entering the fourth quarter, consumer spending at retail outlets and restaurants showed a modest increase when compared to that of the same time period a year ago. Revenue increases were driven in part by gasoline sales (volume) and home furnishings. The latter was attributed to a recovery in household formation rates by millennials. The apparel segment is reportedly highly fragmented. Nonetheless, retailers were able to increase margins on select apparel lines during the past few months. Same-store revenues for the 2015 calendar year are expected to be on par or to increase in the low single digits compared to those of a year ago. Vendor and shelf prices were fairly stable, other than declines in gasoline. Food costs have stabilized over the period. Some capital spending is being reallocated from retail locations to warehousing and logistic projects to adjust for changes in consumer shopping preferences. Holiday hiring is on par with last year's. The retail sector is confronting stiffer labor competition. Higher turnover of managerial staff and hourly workers combined with a smaller pool of qualified workers is driving up wages.
Year-to-date sales of new motor vehicles through October rose 1.5 percent compared to those of a year ago. Dealers reported that light trucks and SUVs are expected to drive the upward trend in motor vehicle sales, at least in the short run. Factors contributing to this trend include low gasoline prices, favorable financing (includes leasing), and the perception by consumers that low interest rates will gradually disappear. One dealer commented that the average vehicle transaction price is much higher than it was two years ago. Year-to-date pre-owned-vehicle sales are moderately higher compared to those of last year. Payrolls were stable over the period, but the market for service technicians is very tight, putting upward pressure on wages.
Banking
Bankers reported a modest increase in demand for commercial credit across loan products, but several remarked that customers are proceeding more cautiously than during the summer. Consumer lending expanded modestly over the period, although some banks noted a downturn in auto lending. This may be due to the greater use of auto leasing by consumers. Little change was reported in interest rates, delinquencies (already at low levels), and loan-application standards. Core deposit balances remain strong. The number of branch offices continues to decline because of consumer preferences for mobile transactions. Nonetheless, some bankers expect that payrolls will rise on net during 2016. Job increases in areas such as regulatory compliance and commercial lending will offset the decline in retail banking jobs. Wage pressure is limited to select job categories.
Energy
Investment in upstream oil and gas projects has been cut back as evidenced by the fact that rig counts have fallen more than 50 percent relative to last year's counts. Nonetheless, regional natural gas output remains at historic highs. Investment in mid-stream projects is expanding slightly, while downstream investment in refinery projects is strong. The economics of ethane cracking remain favorable, a situation which bodes well for constructing at least one of the proposed crackers under consideration in the Fourth District. Expectations call for wellhead gas prices to remain at low levels during the near to medium term. Small, independent exploration and production companies are unable to operate wells at current prices. As a result, they are selling assets to equity capital firms. Employment reductions in the industry continue. One executive reported that labor at all skill levels is readily available, with little need to provide wage incentives. In fact, some job categories are experiencing wage deflation.
Freight Transportation
Reports indicated that on net, freight volume contracted over the period. Volumes grew in construction materials and supplies used by healthcare and business service providers. Declines were prevalent in steel products. One executive reported that the agricultural sector encountered fewer problems getting trucks during the harvest season this year as compared to last year. A majority of our contacts see little change in volume along seasonal trends in the next few months. The industry is boosting shipping rates even though volume is lower. Rate adjustments are needed to cover rising equipment and labor costs. The former includes the soon-to-be-mandated electronic logging devices. Not much customer pushback was reported, perhaps because rate increases were partly offset by declines in fuel surcharges. Capital spending is mainly for replacing older equipment and, to a lesser extent, footprint expansion. Hiring has slowed during the past few months because of the slowdown in demand and is now primarily for replacement. That said, a driver shortage still exerts upward pressure on wages.