June 2012
Regional Economy Grows Modestly amid Concerns over Downside Risks
Southeastern Insights provides a broad summary of economic intelligence gathered through our network of business contacts and other sources throughout the Southeast during the latest Federal Open Market Committee (FOMC) cycle. This report covers the period from April 26 to June 18.
Information gathered through our Regional Economic Information Network is delivered to Atlanta Fed President Dennis Lockhart throughout the FOMC cycle. Our regional executives, who operate out of the Atlanta Fed's six locations and are the primary gatherers of business intelligence, participate in meetings designed to keep President Lockhart informed of regional economic developments. Also incorporated in this input is intelligence from our Advisory Councils, Boards of Directors, and Community and Economic Development staff.
Recent data and reports from the Atlanta Fed's business contacts remained modestly positive in the last days of spring.
For the overall region, employment gains have been tempered, but on the whole continued to show modest increases. Unemployment rates are well below levels seen earlier in the year. Consumer spending is holding up, buoyed by healthy auto sales and strong tourism-related spending. The recent decline in gasoline prices has clearly helped consumers. Manufacturing reports also point to ongoing expansion, led by auto production and energy extraction activity. Residential construction and sales continued to improve slowly from historically low levels of activity.
Cautious optimism
That said, our meetings with business contacts and our Boards of Directors over the last several weeks clearly revealed increased acknowledgment of downside risks, mainly those emanating from Europe as well as growing uncertainty tied to the future path of U.S. fiscal policy. It is important to note we did not detect clear, fundamental shifts to business plans as a result of those risks. We were left with the impression that the probability of softer expectations would increase as the year goes on, especially if there are no signs of progress toward a resolution of the European debt crisis or a clearer view of future U.S. fiscal policy. While there were a few businesses that were experiencing some pullback in demand, most firms continued to report slow growth in sales. Most firms also anticipated that activity would continue to expand at the modest pace experienced over the first part of the year.
As Atlanta Fed President Dennis Lockhart summarized in his June 6 speech in Fort Lauderdale, Florida:
"I expect the recovery process to be slow and drawn out. I think the most reasonable expectation is moderate growth, a slow and possibly halting decline of unemployment, with inflation staying close to the FOMC's 2 percent target. I do not see this narrative changing much to the upside over the medium term."
Members of our Boards of Directors were polled on their view of future activity at their recent meetings. The responses showed that while just over half expect growth in their businesses over the next three months to be better than the previous three months, and one-third anticipated no change, very few see much upside risk to their outlooks.
We also polled our Directors and other contacts on their plans for capital expenditures going forward. More than half expect their firms' spending on new plant and equipment over the next six to 12 months to increase, and just under one-third see it as unchanged. Of those who anticipate increased capital spending, the most frequently cited reason was that the expected growth of sales is high. Many also noted that there was a need to replace information technology equipment. Of those who were planning to cut capital spending or leave it unchanged, the most common explanation was that economic and financial uncertainty was pressing them to the sidelines. The results of both polls appear to confirm the view that while expectations for future activity remained largely positive on net, uncertainty was playing a role in dampening optimism. Along those lines, equipment rental firms and industrial parts suppliers continued to report good results, which appear to reflect the notion that businesses remain cautious regarding capital spending since they are renting equipment rather than making outright purchases.
Labor market questions
This conservative approach is reflected in recent labor market developments. Firms do not appear to be seeking additional workers at the pace indicated by data and business contact reports from earlier in the year. We recently polled our business contacts with several questions in an attempt to get a better understanding of recent labor market dynamics. One issue in particular revealed very interesting responses. For some time we have been hearing that job openings were going unfilled because of a lack of qualified candidates. We wanted to gain insight into whether that was a factor in holding back job growth. A recent macroblog post highlighted the findings.
"Despite the fact that we see some evidence consistent with skill mismatch, it is far from clear that this issue is the smoking gun that explains the current anemic state of job growth. When asked if a dearth of skilled applicants is a persistent problem, our survey respondents overwhelmingly answer 'yes.' But when asked if they have had more difficulty hiring over the past 12 months, the overwhelming majority answered 'no.'"
While it does appear that there is a long-term skill level problem in the U.S. economy, the survey does not support the idea that skills mismatch are more important postrecession than they were prerecession. In other words, input from our business contacts does not appear to support skill gaps as the major source slowing job growth. Also supporting the idea that firms are approaching the future with caution were reports that hiring remains tempered and that many companies continue to rely on part-time or temporary hires to fill immediate labor needs.
Our Community and Economic Development (CED) team recently surveyed regional employment/training and social service providers to ascertain employment barriers for individuals with a high school diploma or less. The main reasons that these individuals cited for ceasing to look for a job even though they would like to work were that potential earnings would not be able to pay for child and elderly care, or they could not find a job and simply gave up. Broader research by Atlanta Fed economists found that one reason the labor force was declining—in addition to demographic reasons tied to the aging population—was that many individuals had returned to school. However, the CED survey found that returning to school and seeking training were not as important for people with a high school diploma or less.
Spending with a caution and purpose
While auto sales and tourism-related spending continued to boost overall spending, our retail contacts reported that consumers remain very conservative. Some areas of consumer credit have increased, but by and large the majority of evidence points to ongoing consumer deleveraging. Consumers seem to be spending with caution and purpose, expanding credit only when necessary to fulfill basic needs. As President Lockhart noted in his Fort Lauderdale speech:
"In the household sector, while consumer credit is expanding, overall consumer debt (including mortgage-related debt) is declining and the debt-service-to-income ratio is shrinking. Overall, deleveraging is arguably a fundamental improvement for the long term as financial institutions and households return their balance sheets to health. However, over the medium term, deleveraging is not conducive to spirited growth."
Supporting this notion are reports from discount retailers, which reflect strong sales in their stores. Restaurant and food service contacts reported that demand has softened a bit, except for the higher-end establishments where it remains strong.
Slow rebound in real estate
Caution and deleveraging continue to be evident in the region's housing sector. Apart from isolated construction activity in highly desirable locations, single-family building activity remains very soft.
Our monthly poll of regional homebuilders and brokers continued to reflect year-over-year gains in home sales during May. More than half of southeastern builders reported that new home inventories were below the year-earlier level in May, while most brokers reported that inventories were flat to down. Based on reports from southeastern brokers and builders, it appears that declining inventories have resulted in some stabilization in home prices. The majority of brokers and builders reported that home prices were flat to slightly up on a year-over-year basis. However, builders and brokers continued to note downward pressure on home prices.
Some contacts suggest that housing prices may not have much further to drop because inventories of distressed properties have declined. In addition, homeowners who are currently underwater on their mortgages still have a way to go in rebuilding equity and therefore it may be some time before they are able to put their homes on the market. However, foreclosures may accelerate in the short term. Some banking contacts noted that they are moving through their portfolio of distressed homes and there has been a decline in demand for contractor services tied to maintaining and repairing real estate owned (REO) properties. The bottom line, as reflected by President Lockhart, is that housing is still a headwind to a broader recovery:
"T]he housing sector remains weak even while showing signs of stabilization and improvement. Home prices—more than house building—influence the health of the broad economy through their effect on consumer attitudes. Home prices in many markets appear to be stabilizing, but there remains a sizable inventory of unsold homes that is likely to work against a sustained firming or upturn in home values."
Meanwhile, multifamily market fundamentals are performing strong. Sales activity has increased, occupancies have tightened, rental rates have grown, and there has been a steady increase in the number of units in the construction pipeline. On the commercial side, there remains little demand for office space and even less for retail. Anecdotal evidence indicates that performance of the retail sector is bifurcated: gateway markets have performed better than smaller markets, malls and grocery-anchored retail have performed better than strip mall shopping centers, and high-end stores have performed better than their value-oriented peers.
Manufacturing growing at a slower pace
The Southeast Purchasing Managers Index (PMI) compiled by Kennesaw State University's Econometrics Center declined 5.6 points from April's level to 57.9 in May. While the reading above 50 indicates an expansion in regional manufacturing activity, a deceleration in the expansion is clear. More troubling, the new orders component of the index fell 13 points to 58.1. The index component that measures manufacturers' outlook also took a hit, falling from 69 in April to 58 in May.
One sector that continued to report strong investment and labor demand is energy. While this is supporting activity in some parts of the Southeast, mainly Louisiana, we do not see this as a sign of an increase in underlying improvement in general economic conditions.
Auto manufacturing also remained solid, but our contacts in both assembly and auto sales see strong demand as a result of consumers needing to replace outdated vehicles that were held onto during the recession. Again, this appears to be idiosyncratic to the auto sector and while supportive of activity in the short term, may not indicate strength in the broader economy.
Business costs moderated
Also noteworthy in the Southeast PMI report was a 23-point drop in the commodity price component of the survey to a level of 42.7, reflecting the fact that more manufacturers reported a decline in input costs than in the previous month. In a related note, low natural gas prices have reportedly provided some cost relief for regional manufacturers.
We see the same trends across sectors as well. June results from the Atlanta Fed's Business Inflation Expectations survey showed a decline in unit cost expectations for the second consecutive month. Survey respondents indicated that, on average, they expect unit costs to rise 1.7 percent over the next 12 months. That number is down from 1.8 percent in May and 2.1 percent in April. Firms also reported that their unit costs had risen 1.6 percent compared to this time last year, which is unchanged from their assessment in May. Our business contacts reported that wage pressures remain modest as well.
Bottom line
In the aggregate, firms continue to report modest gains in sales and orders. However, maintaining flexibility to react to a potential deceleration in demand remains a priority. That potential fall in demand is keeping them from enacting broader expansion plans, holding back capital investment, and limiting hiring. Our overall take on the region is that we continue to see modest growth, but the downside risks have increased going forward.
By Mike Chriszt, a vice president in the Atlanta Fed's research department, and Shalini Patel, a senior economic research analyst.
