Beige Book Report: Cleveland
January 13, 2016
Aggregate business activity in the Fourth District grew at a modest pace since our last report. Manufacturing output increased on balance, albeit at a slow rate. The housing market improved, with higher unit sales and higher prices. Nonresidential building contractors reported continued strong activity. Retailers and auto dealerships saw higher revenues on a year-over-year basis. The demand for credit was stable. Oil and gas exploration remains depressed, while investment in pipeline and midstream projects moved forward. Freight volume trended lower.
Payrolls were little changed during the past six weeks; seasonal factors weighed down hiring activity. Nonetheless, reports indicated an ongoing tightening in labor markets. Wage pressures were reported in the construction, retail, and banking sectors. Staffing firms reported little change in the number of job openings, though there was a bias toward temporary openings. Job placements declined. Overall, input and finished-goods prices were steady other than for commodities, where prices declined further.
Manufacturing
Demand for manufactured products showed a modest rise on balance over the period. Activity for suppliers to the motor vehicle, construction, and aerospace industries remains elevated, but the pace of growth has slowed. Several reports indicated a pickup in production of domestically sold non-durable consumer products. Key factors tempering output include a strong dollar and softness in the energy sector and in some emerging market economies. Exporters told us that low energy prices help in maintaining margins, but they do not completely offset the impact of the strong dollar. Year-to-date auto production at District assembly plants through November increased 1 percent compared to the prior year's level. The steel and primary materials supplier industries remain depressed. Producers continue to struggle against an array of headwinds, including a strong dollar, overcapacity, low demand from the domestic energy sector, and a high level of imports, particularly from China. The aerospace industry may be the only bright spot for primary-materials suppliers. Capacity utilization rates continue to contract, particularly in the steel industry. The outlook by our contacts was mixed. Manufacturers who sell to industrial customers expect flat or sluggish growth, though some anticipate slightly higher revenues from European customers. Otherwise, our contacts expect that business activity will expand during 2016.
Capital spending was allocated primarily for new equipment, with lesser amounts for maintenance projects. Raw material prices were stable, except for primary metals such as copper and steel, for which prices declined. Steel prices have reportedly fallen 40 percent year-over-year. We heard two reports about steel mills that have recently announced price increases in an effort to counteract low price levels that they believe are unsustainable. Finished-goods prices were steady. Selected downward adjustments were made to reflect lower steel prices and to compete with foreign imports spawned by the strong dollar. Manufacturing payrolls contracted over the period, mainly in production jobs. Reports indicated that some laid-off workers were classified as temporary or were part of a normal seasonal downsizing. Wage pressures were contained.
Real Estate and Construction
Year-to-date sales through November of new and existing single-family homes rose 8.5 percent compared to those of the same time period in 2014. The average sales price increased by more than 4 percent. New-home contracts remain concentrated in the move-up price point categories. Condo sales are reportedly increasing. The market for spec homes exists, but is limited by supply-side factors, including difficulty obtaining construction financing and labor constraints. The 2016 outlook of homebuilders was less optimistic than during the past few months. Unit sales are expected to be on par or slightly lower when compared to those during 2015. Our contacts believe that rising interest rates will provide a short-term boost for new-home sales but will impair affordability in the medium- to long-run, especially for buyers in the lower price point categories.
Nonresidential contractors reported continued strong activity, primarily in the commercial segment. The unusually mild winter weather is contributing to stronger than normal revenue flow. Inquiries increased sharply over the period, while backlogs showed a mild expansion. General contractors are optimistic about prospects going into 2016, and they expect stronger revenues on a year-over-year basis, with an improving industrial segment. However, several contractors cited downside risks that they believe the industry will confront in the new year such as the impact of the presidential election, economic problems outside the US, and capacity issues within the construction sector.
Construction payrolls were stable on net over the period. New hires were mainly for project management and business development jobs. Subcontractors remain very busy. They are being challenged by a labor shortage and as a result are selective when bidding. Subcontractors are pushing through rate increases that they attribute to capacity constraints and a need to raise margins. The construction sector remains challenged by a labor shortage across job categories, resulting in upward pressure on wages. Little movement was seen in building materials prices.
Consumer Spending
Mid-way through the holiday shopping season, consumer spending at retail outlets increased on balance when compared to that of the same time period a year ago. Black Friday and Cyber Monday sales were especially encouraging. Product segments selling particularly well included activewear, outdoor recreational equipment, and home furnishings. Contacts experiencing lower revenues attributed the decline to the unusually warm winter weather. Retailers are becoming more optimistic in their outlook, which is being driven in part by enhanced sales opportunities afforded them by e-commerce. First quarter revenues are expected to be slightly above those of a year ago. Vendor and shelf prices were fairly stable, though selected chains ran more promotions than normal. Some reductions in 2016 capital spending plans were announced. Current spending is primarily allocated for brick-and-mortar projects. Hiring is limited to new store openings. Retailers are facing stiff labor competition. Higher turnover combined with a smaller pool of qualified workers is driving up wages.
Year-to-date sales of new motor vehicles through November rose 2.5 percent compared to those of a year ago. Light truck and SUV sales continue to dominate the market, accounting for over 60 percent of new-vehicle transactions (year to date). Dealers cited low fuel prices and strong lease programs as factors contributing to their popularity. New-vehicle sales in 2016 are expected to remain elevated, though some dealers expressed concern about the impact of rising interest rates. Year-to-date pre-owned-vehicle sales are moderately higher compared to those of last year. Dealer payrolls held steady over the period, but the market for sales and service personnel is tight, putting upward pressure on wages.
Banking
Demand for business credit was stable since our last report, but several bankers reported softening conditions during the past few months. They cited as contributing factors less appetite for risk because of recent geopolitical events, a slowdown in the energy sector, and non-bank competitors becoming more aggressive. However, pipeline activity is showing signs of strengthening because of the threat of higher interest rates. CRE lending remains relatively strong. Consumer credit was steady across product lines, though the downward trend in auto lending continued as consumers increasingly turn to non-bank competitors for credit. A slight pickup in residential mortgage applications was noted, a circumstance that bankers attributed to the potential rise in interest rates. Little change was reported in interest rates, delinquencies, and loan-application standards. Core deposit balances remain very strong. Banking payrolls moved modestly higher. Bankers reported a tightening labor market within their industry, one which is contributing to wage pressure, particularly in entry-level jobs.
Energy
The number of drilling rigs operating in the Marcellus and Utica Shales trended lower over the period and is currently almost 60 percent below its peak level recorded in the fourth quarter 2014. Nonetheless, regional natural gas output remains at historic highs. Upstream oil and gas companies are struggling to adapt to low energy prices and are increasingly facing mounting financial difficulties. In order to free up cash for debt service, oil and gas drillers are cutting payrolls and dividends. Reduced demand owing to unusually warm weather has boosted inventories and put further downward pressure on wellhead prices. Reports indicate that investment continues in pipeline and mid-stream projects and that the refining (oil) segment is doing well. Not much change is expected across the sector during 2016.
Freight Transportation
Reports indicated that on net freight volume contracted further over the period. This situation was attributed primarily to weakness in the energy sector, steel, and export environment. Some carriers saw a boost in volume related to seasonal products and building materials and hardware. Our contacts are fairly pessimistic and see little growth in volume along seasonal trends during 2016. One contact noted he is hopeful the current inventory glut will be reduced, a situation which would provide a needed lift to the freight industry. On balance, shipping rates increased modestly even though volume is lower. Rate adjustments are needed to cover rising costs for labor, new equipment, and regulatory compliance. Two of our contacts reported they have pulled back on capital spending, while others indicated that if current market conditions persist, they anticipate adjusting their capital budgets downward. Spending is mainly for replacing older equipment and, to a lesser extent, for maintenance projects. Hiring was flat on balance during the past few months because of the slowdown in demand.