December 13, 1978
Economic activity in the Fourth District continues to expand in response to a high level of production of automobiles and steel and further increases in capital goods. However, manufacturing activity is being supported by some involuntary inventory buildup, especially of consumer goods. While retailers and producers of consumer goods, excluding autos, are not very optimistic over sales prospects, capital goods producers are encouraged because of sizable backlogs and a generally favorable outlook for new orders. Steel operations are expected to continue at 85 to 90 percent of capacity again next quarter. Mortgage loan demand has dropped sharply in recent weeks. Intense efforts are underway to prevent a default by the city of Cleveland on December 15.
Several key industries in the District are manufacturing at rates close to effective capacity, especially primary metals, machine tools, and industrial machinery. Although there are no widespread bottlenecks or shortages such as in 1973 and 1974, shortages of skilled labor—and even dependable labor—are constraining production, especially in machinery industries.
Auto producers and suppliers are still relatively optimistic, despite recent slippage in sales. Suppliers of steel, glass, tires, and auto components report GMC orders coincide with their publicly announced production schedules for the next few months. Also, a major appliance producer is reasonably optimistic that consumers are unlikely to sharply curtail spending for these goods because of continued gains in employment and income and the strong replacement market for major appliances.
On the other hand, other producers and retailers of consumer goods are less sanguine. A major producer of household soaps, detergents, and paper products indicates that year-over-year sales gains in recent months have slowed and are below expectations. In his judgment, high rates of inflation have caused consumers to cut back consumption of personal care products. Retailers of general merchandise also report reduced sales gains in recent weeks. They expect, at best, that this month's year-over-year sales increase will be larger than last month's but well below the increase recorded in December 1977.
Inventories of consumer goods have been built rapidly at both the retail and manufacturing level. According to one report, retailers have cut back reorders to keep stocks from building further, but manufacturers have continued to produce goods in expectation that sales would continue at last spring's high rates. Therefore, some manufacturers have involuntarily added to stocks in recent months.
A recent surge in new orders and backlogs adds support to expectations by some capital goods producers that gains in real spending next year will be in the 5- to 6-percent range, instead of 2 percent or less as indicated in latest surveys. According to some producers, the latest surge in orders reflects a growing substitution of capital for labor because of a shortage of qualified workers, favorable effects of dollar depreciation, and perhaps some double ordering because of shortages. Those firms that produce aircraft and aerospace components, freight cars and railroad equipment, and computer equipment are most optimistic. However, others have less favorable expectations because they have not experienced recent acceleration in orders or because orders have been relatively flat with little prospect for a pickup. Major machine tool builders report strong but not accelerating order activity, and one builder pushed back his expectation of a peak in new orders from third quarter 1978 to the spring of 1979. A major producer of coal mining machinery believes many of his product lines are at cyclical peaks in orders. Still others see a relatively flat year ahead because of a lack of broadly based strength in capital goods. A major builder of basic processing plants remarked that his backlog is not large enough to sustain operations through a mild recession as has typically been the case in the past.
Steel producers are operating close to 90 percent of capacity and are growing more confident that this rate will carry at least through the first quarter of 1979. Orders have picked up strongly and those for January and February are considerably better than anticipated. Strong demand from the construction industry and capital goods produced the unexpected strength in steel. Producers have not yet had setbacks from the auto industry. Moreover, domestic steel users may be substituting some foreign for domestic steel, as higher trigger prices either reduced the price advantage of foreign steel or boost foreign above domestic prices. The strike of independent steel haulers is disrupting as much as 5 percent of total steel shipments this month, especially in the Pittsburgh producing area, although neither steel production nor employment has been affected by the strike.
Mortgage loan demand in recent weeks has weakened in response to a usual seasonal drop and further tightening in lending terms by banks and S&Ls. Mortgage money generally is available, although borrowers are discouraged by rates that are as high as 11.5 percent for a 95 percent loan. Lenders are charging 9.75 percent to 10.75 percent for a 60 percent loan. S&Ls are having no difficulty in rolling over the certificates now maturing, and some report that strong deposit flows are continuing into early December because of the money market certificates. Those S&Ls that acknowledge use of funds obtained from certificates for short-term investments, especially CD's, rationalize their actions on grounds they can more easily support continued issuance of certificates, while at the same time making funds available to prospective home borrowers.
In the city of Cleveland, serious proposals have emerged in a last-minute effort to avoid default on $15.5 million in bond anticipation notes that mature December 15. A plan developed by an outside consultant calls for resolution of the sale of the municipal light plant and the passage of a state law establishing a fiscal control board with power to raise the income tax rate by 0.5 percent to 1.5 percent. The rate increase would make Cleveland's rate comparable to other Ohio cities and add about $30 million in annual revenues. The city administration plans a layoff of 600 fire, police, and service workers starting next year which would save about $6 million. It also has scheduled bill payments for December 31 so that checks will not clear the banks until 1979. Even with a rollover, the city would still face the possibility of default when an additional $25 million in notes begins maturing next summer.