June 15, 1977
Economic activity in the Fourth District continues to expand moderately, except for recent flattening in retail sales. Retailers have experienced some slowing in sales, including new cars, although producers are still optimistic about prospects. Capital goods producers expect spending in 1977 will rise at least in line with the latest Department of Commerce survey on capital spending. The recent surge in steel output, supported by a high level of auto production and inventory buildup, is expected to end shortly. Economists who met at this Bank on June 3 expect the rate of growth in real GNP to slow to an annual rate of about 4 1/2 to 5 1/2 percent from 1977-III to 1978-II. Bank and savings and loan officials see little evidence on speculation in housing, but savings and loan associations have been expanding the use of second mortgages as a source of consumer financing.
Retailers indicated a mixed pattern of consumer spending over the past several weeks. Some department store officials are concerned about near-term sales prospects. One reported sales in May were a bit better than in April although still below expectations in real terms. In his view, consumers are still paying for high fuel bills and buying new cars; therefore, sales promotions might be necessary to stimulate department store-type goods and to hold inventories to desired levels. Another executive fears consumers will retrench because of the rapid buildup in debt in recent months. An official with a producer of nondurable housewares, including wall coverings and window shades, indicated a flattening in sales in recent weeks. Others are still relatively optimistic about sales prospects. A loan officer with a major bank commented that increasing demand for loans to finance autos, boats and recreational vehicles suggests greater consumer confidence in economic prospects than indicated in the latest consumer surveys. While somewhat off from the pace of March and April, new car sales in recent weeks remained strong, according to several new car dealers. One dealer stated that consumer interest in large cars stems from the belief that buyers get the most for their money from large cars. An economist with a major auto producer expects an average annual rate of new car sales in the second half of 1977 of about 11 million units, compared with an average annual rate of about 11 1/2 million units during the first half of this year. He does not regard the runup in consumer debt as a major concern and believes that consumers are unlikely to step up their rate of personal savings much above 6 percent of disposable income.
Capital goods producers generally expect that the increase in capital spending this year will at least match the 12 percent increase indicated in the latest Department of Commerce survey. An economist with a major capital goods producer expects a 14 percent increase in capital spending this year and 15 percent in 1978 (about 8 percent in real terms each year). A producer of transmissions, axles, and other equipment for trucks expects a 12 percent increase in capital spending this year and continued strength in heavy-duty truck sales, although they are likely to slow by mid-1978. Small gains in capital spending are expected in a few industries. An economist with an oil refinery in the District expects refinery capacity in the U.S. will expand by 500,000 barrels this year but only 200,000 barrels next year, because of uncertainty over the Administration's energy program. At a meeting of sixteen financial officers from Cincinnati-based firms held by this Bank on June 10, several officials commented on the difficulty of devising projects that will meet a satisfactory return in investment. Contributing to these difficulties are such factors as changes in environmental and OSHA regulations, inflation and other shocks in the economy. Some say that the target rate for return investment has been increasing in recent years, while others feel the target may not have increased but that it is more difficult to achieve the same target rate. Several asserted that despite a need to replace some existing inefficient capital stock occasioned by higher costs of energy, new spending projects are hindered because of uncertainty over return on investment.
Economists who met at this Bank on June 3 expect that the expansion will continue at a relatively moderate pace at least into the second quarter of 1978. The median forecast of 29 economists indicates an increase in real GNP at about a 6 percent annual rate for the second and third quarter of 1977, followed by a rate of increase of from 4 1/2 to 5 percent (annual rates) from the fourth quarter of 1977 to the second quarter of 1978. The slower pace of growth expected for the first half of next year is attributed largely to a slower buildup in inventories than in 1977 (annual rate of about $16 billion for the first half of 1978), and to a reduced level of domestic new car sales (9.0 million annual rate). The group also raised their forecasts of the implicit price deflator to about a 6 percent annual rate from the second quarter of 1977 to the second quarter of 1978, compared to the 5.6 percent annual rate expected last February. Consistent with the median forecast, a bank economist expects continuing strength in business loan demand to finance working capital needs, an increase in short-term interest rates of 100 to 150 basis points by year-end 1977.
Loan demand continues to be strongest for residential and consumer credit, but is still mixed for business loans. Banks and thrift institutions have indicated strong mortgage loan demand, especially for single-family dwellings, while apartment construction remains generally weak in the District. Several savings and loan officials expect their liquidity will be reduced by the end of this summer, and some expect to increase borrowings from the Federal Home Loan Bank to support a high level of mortgage commitments. Several large district banks indicate a strengthening in demand for business loans, although some still report an irregular and mild upward trend.
Bankers and officials with savings and loan associations see little evidence of speculation in housing, that is, purchasing of non-owner occupied housing. Responses generally indicate builders and lenders have stepped up construction in anticipation of continuing rising demand for single-family dwellings. Some attribute lack of speculation in housing in this area to a relative balance between supply and demand for housing, a relatively stable population, and price increases in housing that have recently averaged about 10 percent annually, considerably less than in some other parts of the country. One builder, however, pointed out that speculation has increased for land in some non-urban areas where values have been rising rapidly, especially as residents leave locales where schools have been or will be desegregated.
There appears to be considerable difference between District banks and savings and loan associations in the use of equity loans and second mortgages. Banks do not seem to be promoting equity loans. Moreover, few banks seek or make second mortgage loans. Those advancing second mortgage loans do so only if the bank holds the first mortgage and if the loan is for home improvements. Some banks prefer to rewrite the first mortgage as an alternative to making a second mortgage loan. Where made, second mortgages are used for swing loans, for periods of 3 to 6 months. On the other hand, savings and loan associations contacted are involved in equity loans and second mortgages, which have been gaining in use in recent years. Savings and loan associations seem to be more aggressive in the use of second mortgages as a source of consumer finance. One official explained equity loans are made when used as a swing loan, but second mortgages have a variety of purposes, ranging from home improvement to financing a college education. Another official feels a second mortgage involves no greater risk than the first; the amount of a second mortgage is restricted to the difference between the original loan less the unpaid balance, and for a home improvement loan to the difference between the original value of the mortgage and the appraised value of the property.
Several bankers have suggested that District farmland prices have continued to increase despite lower grain prices and the associated effect upon returns in farming. Cash rents are also reported as rising in line with farmland prices, a matter of concern to rural bankers. Often times landholders have purchased farmland to enlarge their present holdings which were purchased at significantly lower prices. In these situations, the equity stemming from past increases in farmland prices provides the base for enlargement. Other bankers noted some effect on land prices by buyers who are not presently engaged in commercial agriculture.