Beige Book Report: Cleveland
March 11, 1980
Business activity in the Fourth District continues to show strength, although accelerated inflation and higher interest rates have caused some respondents to lower their forecasts of GNP for 1980. Consumer spending continues to expand, and most respondents expect only a gradual rise in the savings rate. The steel industry is experiencing a rebound in orders because customer attitudes about inventories have apparently been revised upward. Consumer loans are showing signs of slowing because of higher interest rates, C&I loans remain strong, especially among larger banks. Several S&Ls report a sharp decline in mortgage lending and few expect any improvement in the near future.
Economists who attended a Fourth District Economists Roundtable held at this bank on March 7 still expect a recession in 1980, but one that is more mild than they expected at a similar meeting last November. Of sixteen economists who attended the meeting, fifteen forecast a slight decline in real GNP this quarter and expected that the balance of the recession would get underway in the second quarter. The meeting forecast of this group shows a 0.2 percent annual rate of decline in real GNP in the first quarter, 2.8 percent decline in the second, 1.6 percent decline in the third, and a recovery of 0.5 percent and 2.5 percent in the fourth quarter of 1980 and first quarter of 1981, respectively. Next quarter reduction in GNP is associated largely with a substantial reduction in the rate of growth in nominal consumer spending and another decline in residential construction. Skepticism over a mild recession scenario was expressed by some of the group who felt that high inflation and high interest rates may result in a more serious recession than indicated in immediate forecasts.
Some of the upward shift in expectations about the economy was associated with continued, though mixed, strength in consumer spending. Consumers have been cutting back usage of some goods in order to have money available for goods that are perceived to be a hedge against inflation or that are perceived as a bargain. A major producer of appliances reports a better than expected order pattern in recent weeks, after weakening in December. A producer of nondurables, however, has not experienced the increase in his business that was expected because of high inflation. An economist for a major department store chain expects a 10 percent increase in total goods sales (current dollars) in 1980, which is still below his expected inflation rate. An automotive economist reports that consumers are taking advantage of price discounting on 1979 models, but sales of 1980 models have been adversely affected. Although most respondents expect the personal savings rate to remain low in the near term, they also expect a gradual pickup to about a 4.5 percent rate by year-end. Demographic changes and inflation psychology are the most often given explanation for the low rate.
Reflecting the changes in expectations, new orders and shipments in the steel industry have shown unexpected strength since the beginning of the year. As a result, some recalls of workers have taken place. According to one steel economist, many customers had cut orders more than necessary at the end of 1979. Most of the cuts came from steel service centers in attempts to liquidate inventory. Now, however, steel inventories are judged low and some customers have begun to rebuild stock. A steel official reports a 50 percent increase in bookings during January and February, but attributes some of that strength to hedging against an April price increase for flat-long steel. The capacity utilization rate in the industry is currently about 83 percent of capacity, but new orders, according to a steel economist, are equivalent to a 90 percent rate. However, some steel officials expect customers to be under pressure to cut inventories because of the high cost of financing inventories and because the availability of steel is no longer a serious concern.
Consumer loans have softened. One District banker reports installment loans have been reduced because credit terms have tightened. Although demand remains strong, loans are only being made to better customers who meet stringent requirements, including higher down payments. One bank official reports that interest rates on auto loans have been boosted to 17 percent, which is expected to dry up consumer loans and to affect auto dealers who cannot sell to commercial buyers.
Larger banks generally expect increased demand for C and I loans, while smaller banks report C and I loans to be relatively slack. One bank official reports that firms are cutting back on equipment spending and some firms postponed debt offerings. Some banks exposit nervousness among borrowers about credit availability, but they've discouraged requests for increased lines of credit. One bank economist reports increased inquiries by utilities and expects higher loan volumes in the near future. Large firms can still pay higher interest rates and strong loan demand is expected for several months, partly because of inventory demand, hedging against further increases, and a surge in acquisition loans. On the other hand, some small businesses are cutting back because of higher interest rates.
Mortgage lending weakened substantially in February and several S&Ls are reported to have withdrawn from the market in recent weeks. Mortgage rates vary from 14 1/2 percent to 16 percent, plus two points or so. One S&L official states that current mortgage rates and credit conditions disqualify many potential buyers. A respondent reported a 50 percent decline in loans and a 60 percent decline in commitments in February from a year earlier, and expects March to be even worse. A supplier to the residential construction industry confirms that a collapse in orders has occurred. Housing, according to an S&L economist, will continue to weaken in 1980 until interest rates decline. Although prolonged high interest rates are encouraged through S&Ls, several official expressed concern that credit controls could accelerate disintermediation. Since 35 percent of all certificates mature in July, interest rates must decline by then to prevent a total collapse of the mortgage market, according to one S&L official.