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San Francisco: December 2018

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Beige Book Report: San Francisco

December 5, 2018

Summary of Economic Activity
Economic activity in the Twelfth District continued to expand at a moderate pace during the reporting period of early October through mid-November. Conditions in the labor market tightened further, and wage growth was moderate. Price inflation increased moderately. Sales of retail goods expanded somewhat, while activity in consumer and business services was solid. Conditions in the manufacturing sector strengthened, and conditions in agriculture improved modestly. On balance, contacts reported that residential and commercial real estate market activity expanded at a solid pace. Lending activity ticked down modestly.

Employment and Wages
Conditions in the labor market tightened further. Across the District, contacts reported an increase in competition for workers and a shrinking pool of qualified applicants. A major shipping and logistics business in Northern California revised upwards plans to hire seasonal workers and expected to convert more seasonal hires to permanent employees than in the past. Contacts continued to note shortages of construction workers, even as the real estate market cooled somewhat in some parts of the District. A contact in the business services sector in Washington observed increased competition from other sectors for skilled accounting and information technology professionals that are in short supply across the state. A few contacts in the banking and agriculture industries in California slowed their pace of hiring due to productivity-enhancing investments.

Wage growth continued to increase moderately across skill levels and industries. Nonwage compensation also increased at several businesses, often in the form of additional paid vacation days. Many contacts reported that turnover was up noticeably, causing labor costs to rise more than anticipated, as new hires negotiated higher starting wages. A contact in Northern California reported that salaries for software engineers continued to increase noticeably. An airline company in the Mountain West noted moderate increases in starting salaries for pilots.

Price inflation increased moderately over the reporting period. Contacts reported a moderate pickup in the pace of price increases at retailers and quick service restaurant chains, partly due to rising labor costs at these businesses. Businesses in the shipping and logistics industry planned to apply holiday surcharges due to high freight volumes and previous increases in energy costs. A contact in the steel industry was able to increase selling prices modestly due in part to reduced global competition. A contact reported that some businesses in light manufacturing that source input materials from China faced higher production costs. Potato prices were down modestly due to supply outpacing demand after a strong harvest.

Retail Trade and Services
Sales of retail goods expanded somewhat over the reporting period. A contact in Arizona noted strong consumer demand in the region, which drove retail sales noticeably higher compared to this time last year. A contact in the Mountain West noted that consumers have begun to tend to purchase their lower-cost, basic goods online and higher-cost, luxury items in stores, straining brick and mortar establishments that sell everyday products. A major quick service restaurant chain based in Washington reported that in-store traffic continued to trend downward at a gradual pace.

On balance, holiday sales are expected to increase moderately relative to last year's season, due in part to solid momentum in consumer confidence and spending. In the shipping and logistics industry, rising volumes in the past month have led some contacts to expect a robust holiday shopping season. One contact pointed to last year's income tax changes as a driver of a more optimistic outlook for holiday spending. However, another was attentive to the negative impact that the recent stock market declines could have on spending.

Activity in the consumer and business services sectors was solid. A contact in the shipping and logistics industry reported a further increase in demand for freight services and brisk competition in the industry. A contact in Northern California observed strong demand for software products to address cybersecurity threats and to enhance business productivity. Demand from leisure guests in the hospitality industry was solid, while near-term business reservations declined further.

Conditions in the manufacturing sector strengthened. Contacts in the steel industry reported that capacity utilization remained stable at an elevated level despite a tick down in sales to automakers and builders. Solid domestic demand from other sectors and beneficial trade policy developments helped to bolster the industry. Contacts in Northern California observed that new orders of semiconductors were strong, input materials were readily available, and inventory levels were healthy. Deliveries of commercial aircraft increased slightly from the same period last year, while new orders grew significantly.

Agriculture and Resource-Related Industries
Conditions in the agriculture sector improved modestly. Profits at beef and pork producers rose noticeably on a year-over-year basis, due to strong domestic demand. A contact in Central California reported that yields were generally solid but that trade policy uncertainty continued to limit the ability of growers to secure longer-term sales contracts. Potato and wheat yields in the Mountain West were strong, though exports of these products declined moderately. Drier-than-usual conditions in parts of California lowered yields for select crops, like nuts and tomatoes, but contacts noted that inventories were at an adequate level to meet demand.

Real Estate and Construction
Activity in real estate markets continued to expand at a solid pace, though many contacts observed that the pace of expansion has moderated somewhat in recent months. Residential construction was mixed. In the Mountain West and California, contacts observed generally solid construction activity and a shift into multifamily construction from single family in certain regions. Contacts in the Pacific Northwest reported that building slowed somewhat, citing expectations of weaker demand due to rising mortgage rates as one factor restraining new projects. In most of the District, home prices and rents decelerated modestly, though prices were still high by historical standards, supported by continued elevated demand. Contacts noted slightly more positive developments in the commercial real estate market. A contact in Northern California observed solid leasing demand from businesses, in some cases resulting in rents above advertised rates. Contacts were generally hesitant to interpret any recent moderation in real estate activity as a definite shift in the trajectory of the market.

Financial Institutions
Lending activity ticked down modestly over the reporting period. Growth in loan demand slowed modestly overall, with several contacts attributing most of the slowdown to higher interest rates. Net interest margins were flat to down slightly. Activity in the venture capital market was strong and equity valuations remained elevated despite some recent corrections. Credit quality continued to be healthy.