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Beige Book Report: Cleveland

April 19, 2017

Summary of Economic Activity
Economic activity grew moderately on balance across the Fourth District since our last report. Labor markets continued to strengthen, with moderate to strong wage gains. Upward pressure on prices paid by producers increased; selling prices rose, though at a slower pace. Consumer spending was stable; Internet and mobile transactions continued to offset declines at brick and mortar establishments. New motor vehicle sales strengthened. The outlook by manufacturers noticeably improved as factory output picked up. Nonfinancial services firms experienced moderate revenue growth overall. Freight volume expanded over the period, especially for steel, coal, and consumer products. The housing market cooled slightly, but unit sales remain above year-ago levels, and selling prices are higher. Commercial builders are experiencing stronger than usual inquiries and growing backlogs. Lending pipelines were satisfactory.

Employment and Wages
District payrolls continued to expand at a steady, albeit slow, pace. Increases were prevalent in the financial services, construction, and manufacturing industries. Brick-and-mortar retail was the only industry to report an overall staffing decline. Here, several contacts announced job cuts because of store downsizing or closures. Staffing firms noted that their clients expect that both the pace of hiring will pick up as the year progresses and the number of openings for permanent jobs will rise. One staffing firm reported that billable hours for the first quarter were 20 percent higher compared to the historic average. Workforce development officials told us that while the number of entry-level jobs is rising, finding candidates with the required core skills is difficult. Job churning has become an issue confronting many hiring managers. Wage increases during 2017 are expected to average about 3 percent, with significantly higher increases needed to retain high-skilled employees.

Upward pressure on prices paid by producers increased over the period. Manufacturers attributed increases to the partial recovery in steel and other primary materials prices. A homebuilder said that his industry is feeling pent-up pricing pressure from materials suppliers. He also cited pressures on capacity utilization in the materials manufacturing industry. Oil and gas field materials prices moved higher because of the expansion in upstream activity. The steepest increases were for steel and sand. Even though producer selling prices are rising, they have not kept pace with the upsurge in input costs. A few contacts noted that productivity increases have helped soften margin contraction. Manufacturers, homebuilders, and general building contractors experienced little pushback when attempting to raise their selling prices. Concerns were raised about rising apparel and motor vehicle prices if a border-adjustment tax were enacted.

Consumer Spending
Consumer spending remains stable. Growth in the number of transactions completed over the Internet or via mobile devices offset declines in brick-and-mortar transactions. Traditional retailers reported that mall traffic continues to weaken and that there is less impulse buying. One chain said that the apparel segment has been on a downswing as consumers' disposable income is being allocated for other priorities. Another chain cited the unusually warm weather as a factor for the decline in purchases of cold-weather merchandise. Retailers noted that they have little room to raise shelf prices. As a result of these circumstances, brick-and-mortar retailers are cutting back on inventories and capital spending. Year-to-date unit sales through February of new motor vehicles increased more than 5 percent when compared to those of the year-earlier period. The share of light truck transactions continues to trend higher.

Industrial Production
Manufacturing sentiment has noticeably improved during the past couple of months, though a few large manufacturers cautioned that the new found optimism may be unwarranted. Reasons for the optimism include slowly improving global economic conditions, a partial recovery in commodity prices, and expectations for tax and regulatory reform on the part of the new administration. Activity for suppliers to aerospace, automotive, construction, and Internet-retailing end markets remains elevated. Factors tempering output growth include the strong dollar and trade policy uncertainty. Year-to-date production through February at District auto assembly plants fell about 2 percent when compared to that of the same time period during 2016. Reports indicated that a growing number of manufacturers are expanding capital budgets. Additional monies are being allocated primarily for new equipment and long-stalled maintenance projects.

A small rise in oil and gas drilling is spurring additional investment in midstream and pipeline projects. Drillers are being motivated by a slow upward trend in wellhead prices and a need to perform on their leases. With the new presidential administration, oil and gas producers are hopeful for a less restrictive permitting process.

Real Estate and Construction
Year-to-date unit sales through February of new and existing single-family homes increased 1.6 percent compared to those of a year earlier. The average sales price rose more than 6 percent. Homebuilders reported that rising interest rates and rising list prices are motivating potential buyers to move off the fence. The impact of these factors on demand for new home construction may not be known for months owing to the significant time lags in the new home buying process. Year-to-date estimates of single family construction starts were much higher in Ohio compared to a year earlier. Strongest demand was found in the first-time and move-up price point categories. Sales of high-end homes continued to slow.

Nonresidential contractors reported rising optimism across their markets. The number of inquiries was described as strong for early on in the year, and backlogs are strengthening. Strongest demand was for public infrastructure projects, commercial buildings, and warehousing and distribution facilities. Contractors noted that demand for retail-related work has diminished significantly. There is optimism about the impact that national infrastructure legislation would have on the construction industry. However, if an infrastructure bill were passed, the impact would not be felt until 2018 at the earliest.

Financial Services
Bankers generally remain satisfied with their credit portfolios. Although customer confidence is higher, that confidence has not yet translated into additional commercial or retail lending. Bank customers seemingly are waiting for more definitive proposals on tax and regulatory reform from the new administration before moving ahead with projects. On the commercial side, strongest demand is for CRE loans and M&A financing. Two large-bank contacts reported that manufacturers are increasingly turning to non bank sources for capital project financing. Several bankers noted a seasonal decline in consumer lending overall, especially for credit cards. A drop in auto loans was attributed to increased competition from OEM captives and credit tightening for subprime applicants. A rise in interest rates and low existing-home inventory were cited as factors for a decline in mortgage borrowing.

Nonfinancial Services
Professional and business services firms reported moderate levels of activity on balance over the period. Strongest demand was seen by bioscience, IT, logistics, and management consulting firms. An IT executive reported that year-to-date results have been unusually positive so far. A management consultant said that his firm has recently seen a broad-based rise in demand. Factors contributing to increased demand are a stronger economy and a need for assistance in navigating emerging uncertainties such as changes in health-care laws.

Freight volume expanded over the period on balance, and this expansion was attributed to improving economic conditions and lean inventories. Increases were seen primarily in shipments of steel, coal, and lower-value consumer products. A few carriers reported that they were able to push through rate increases.