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Cleveland: June 2022

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Beige Book Report: Cleveland

June 1, 2022

Summary of Economic Activity
Business activity decelerated and was slightly positive as firms grappled with ongoing supply chain challenges, tight labor market conditions, and escalating costs. These challenges also clouded the near-term outlook for the economy, a situation leading firms to be conservative with their investment spending. The soft growth of demand was evident in most sectors save for professional services, which grew strongly. In a change from recent reports, concerns about COVID-19 were largely absent from commentaries, and contacts were mainly concerned about the uncertainty of the economic outlook and the inflation environment. Employment rose moderately, but firms continued to report that they were understaffed. Contacts suggested they were more focused on employee retention than in the recent past and had broadly raised wages and bonuses. Costs rose for a wide range of items, most notably for energy and food. Firms generally had little difficulty raising prices to offset cost increases, and many contacts expected upward pressure on prices to persist over the next 12 months.

Labor Markets
Employment rose moderately. A few manufacturing and hospitality firms observed a slight increase in the number of job applicants. That said, many firms said it remained difficult to find workers and that they were operating below desired staff levels. One manufacturer said that the firm's hiring activity was maintaining its staff level and that it was 10 percent short of its desired level. Staff turnover was high for many firms, a fact which they attributed to a variety of factors including retirements, employees' leaving for other higher-paying jobs or opportunities to work remotely, and burnout with workloads. Several contacts observed an increase in workers' quitting their jobs without having lined up another one. One workforce development agency said that it had become so difficult to find workers that the entity resorted to essentially knocking on doors in the community to find potential workers.

Amid tight labor market conditions, reports of wage increases remained widespread. Many reported that they were more focused on retaining workers and that in addition to raising wages, they were boosting variable pay. Some firms instituted retention bonuses, while others shifted from giving bonuses annually to giving them more frequently to aid retention. A few firms reported that employees had become more concerned about rising living costs and were demanding more pay. One university let employees work from home more often to reduce the impact of rising fuel costs. Contacts generally expected wage pressures to remain high over the next 12 months.

Most contacts reported that nonlabor costs rose for a broad range of items. Higher energy costs were a particular pain point, but other inputs, including food, paper products, building materials, and IT equipment, also increased in cost. There were more reports that vendors were adding fuel surcharges, even in instances in which that was not the norm. A few contacts reported that lumber prices declined and that steel prices plateaued. However, these decreases were outweighed by increases in other input costs. Contacts generally expected upward pressure on nonlabor costs to remain high over the next 12 months. One contact at a business association noted that its members had been hopeful in the recent past that cost pressures would abate sometime this year, but that optimism had waned recently.

Most firms raised prices as they passed through higher costs of labor, materials, and energy to customers. Contacts generally reported that they had little difficulty passing through costs to customers. However, some consumer-facing firms observed that customers were starting to trim expenses because of higher food and gas prices. One large grocery chain said that "customers have recently taken aggressive steps to save. They've shifted from national brands to cheaper store brands. They are also doing things such as purchasing half a gallon of milk instead of a gallon." Contacts broadly expected to continue to push up their prices over the next 12 months to keep up with rising costs.

Consumer Spending
Reports suggested that consumer spending was little changed overall, although there was variation by segment. General merchandisers and apparel retailers reported improved demand, while restaurateurs reported a pickup in sales related to improved weather and the onset of wedding and event season. By contrast, auto dealers reported that sales declined even though demand was elevated. One contact explained that auto dealers were selling every car they received from manufacturers, but the number of sales was lower because of limited inventory. Retailers expressed concern that high inflation could weaken consumer spending in the near term, but hospitality contacts remained optimistic that activity would continue to increase going into the summer.

Demand for manufactured goods softened following strong growth in the previous period. High inflation, supply chain disruptions, labor shortages, the war in Ukraine, and COVID-19-related shutdowns in China contributed to heightened uncertainty about the economic outlook and caused some manufacturers' customers to reduce orders. Despite softer demand, many manufacturers noted that they still could not meet demand because of shortages of workers or inputs. The unreliability of supply chains motivated several firms to temporarily move away from just-in-time inventory management and to stockpile supplies where they could. Spending on capital equipment was modestly positive, with firms saying they were preserving cash, could not get equipment, or were cautious because of rising prices and economic uncertainty. On balance, manufacturers expected demand to increase modestly in coming months.

Real Estate and Construction
Demand for residential construction and real estate softened. Contacts reported that higher home prices and interest rates had reduced affordability and that many potential buyers had become increasingly concerned about the economic outlook. Although contacts expected housing demand to soften further, they noted that demand remained strong overall. One homebuilder expected rising interest rates would have less of an impact on demand for residential construction than it would for other industries because of the shortage of available homes.

Nonresidential construction activity slowed because of rising interest rates and construction costs, although it remained positive. One general contractor noted that building costs have escalated to the point that prevailing rents are no longer able to support development costs. As a result, some clients delayed or scaled back projects. Contacts anticipated that nonresidential construction activity would diminish further as higher interest rates and cost pressures persist in the near term.

Financial Services
Overall, loan demand increased modestly. Contacts reported some improvement in commercial and industrial loan demand. By contrast, demand for mortgages declined, a situation which bankers attributed to low housing inventory and higher mortgage rates. Demand for auto loans also declined, and this decline was attributed to the limited inventory of vehicles for sale. Lenders noted that delinquency rates for commercial and consumer loans remained low but that they expected higher borrowing costs would lead to an uptick in delinquency rates in the months ahead. Core deposits remained steady, although multiple bankers said they expected deposits to decrease in the next couple of months as households draw on their savings to cope with rising prices. Looking ahead, bankers expected loan demand to slow as interest rates rise.

Professional and Business Services
Professional and business services firms continued to report strong activity. Demand for IT-related services such as artificial intelligence, software services, and authentication services, was especially strong. One software provider indicated that labor shortages pushed some firms to seek software and cloud-based solutions to assist with administrative tasks. Contacts anticipated demand for professional and business services would remain strong in the near term.

Freight demand remained soft following a decline in the previous period. Supply chain challenges had variable impacts on firms. While COVID-19-related shutdowns in China reduced the need for freight from port cities, demand for air freight was reportedly strong. One airport contact reported a recent double-digit increase in air cargo volume. Looking forward, contacts expected demand to improve slightly in coming months.

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