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Southeastern Insights

September 2012

A Slow, Apprehensive Expansion

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 August 2 to September 13.

Last month in Southeastern Insights we wrote that information gathered from the business community in July led us to conclude that cautious optimism with regard to their short-term outlook had become even more cautious. Reports from our business contacts and directors in August and early September were little changed. The expansion of economic activity remained positive but slow. However, by the end of August, there were even fewer signs of optimism.

These reports suggest that most businesses appear to have resigned themselves to an environment where growth is likely to remain modest. While some contacts were a bit more pessimistic, and others remained optimistic, the vast majority were planning on no measureable improvement in the near term. Importantly, contacts who indicated that they had seen some modest improvement recently were careful in noting that they did not see this as a permanent shift to a stronger level of activity.

Outlooks reined in
We detected a modest pullback among our contacts from an already-soft outlook. For example, fewer directors (from the Atlanta Fed Board and our five branch boards—44 directors in total) expect any improvement in the rate of growth for their businesses over the short term than did so earlier in the summer.

In fact, back in June about half of our directors expected growth in their businesses to increase over the next three to six months. Now only one in four see any short-term improvement in growth. The majority of our directors feel that growth will remain relatively the same as it is currently, and less than 10 percent anticipate a slowdown in growth over the next three to six months (see chart 1).

chart 1

As for the longer-term outlook, the majority of business contacts anticipate improved conditions in 2013. When pressed on why they expect next year to be better than this year, answers vary but tend to fall back on the expected elimination of some degree of uncertainty, whether tied to Europe, the "fiscal cliff," or tax and regulatory policies. Most contacts say these uncertainties have been limiting longer-term business planning and tied this to being one reason the economy is not currently performing better.

When asked about the risks to their outlooks, most business contacts said risks were balanced, although more contacts saw downside risk than did at the time of the last FOMC meeting (see chart 2). However, contacts with ties to construction and auto production and sales saw more of an upside potential in near-term activity.

chart 2

Labor markets unchanged
A review of Regional Economic Information Network (REIN) reports on labor market developments over the past FOMC cycle does not reveal a "downshift" in hiring. That said, reports do not indicate an increase either. The overriding theme from the current FOMC cycle, and from the last several cycles, is that businesses remain very conservative and are only hiring full-time staff to meet current needs. We saw some acceleration in hiring earlier in the year based on the need to staff up to necessary levels, but that  increase of hiring tapered off in the spring (see chart 3).

chart 3

There was little evidence that firms see the need to add staff to meet expected needs. Hiring seems to be concentrated in getting to the appropriate staffing levels to accommodate for growth in business specific to new customers, which mainly reflects market share gains by these companies. Evidence that hiring is tied to organic growth is limited.

Weak sales expectations and a lack of clarity about the near-term outlook were cited most often when businesses were asked why their hiring intentions remained subdued. With regard to the latter, we continue to hear that uncertainty over tax and regulatory policies was a significant factor in keeping businesses conservative in their approach to hiring.

When considered in total, our take is that it appears that weak sales expectations were the overriding factor in limiting hiring. When firms see clear evidence of increasing sales, hiring is taking place. However, when improvement is marginal or volatile or unknown, uncertainty issues are factoring into decisions to keep workforce levels unchanged.

In sectors where demand is strong, hiring is taking place (see the table). For example, energy exploration and extraction firms are or planning to increase their workforces. Auto manufacturers and suppliers are running at capacity and increased demand will result in either additional hours or staff. Some auto-related manufacturing contacts are hiring and are looking at changing their scheduling practices to allow more upside production flexibility. Another area where some hiring momentum appears to be building is the housing sector, where some builders and building products manufacturers reported adding to staff to meet increases in broader demand. That said, we have not seen a turn in the data with regard to construction employment data through July.

table 1

Many companies reported that they are shifting existing employees' responsibilities from less productive divisions to more productive areas as they struggle to restructure themselves to adapt to current conditions. In addition, the underlying, ongoing theme of technology replacing labor in certain occupations—most notably those that can be described as performing routine tasks—continues.

And the ongoing theme of difficulty finding qualified workers for some specialized positions was reinforced during the current FOMC cycle. Trucking and energy firms were the most vocal about this lack, but across the board firms were searching hard to find qualified IT-related workers, engineers, and finance/accounting experts.

Our bottom line is that demand—or the lack thereof—appears to be the driving force behind hiring decisions. Uncertainty and limited visibility is having an impact on hiring decisions at the margin. The ongoing drive for efficiency through the application of technology is also playing a role in limiting overall increases in workforces.

Prices appear stable
Businesses reported some relief on input prices and little change in wage plans, although some employers noted that they were increasing starting pay for workers with specialty skills. The potential impact of higher food prices was noted by many companies across several sectors. Paired with the recent rise in gasoline prices, higher food costs will have a negative impact on lower- and middle-income consumers, according to community development contacts.

Our latest survey showed that business inflation expectations inched up a bit in August, but remained in check. Survey respondents indicated that, on average, they expect unit costs to rise 1.9 percent over the next 12 months. That number is up from 1.7 percent in July and roughly on par with recent year-ahead inflation forecasts of private economists. Projecting ahead, firms continue to anticipate little or moderate upward pressure coming from input costs over the next 12 months (see chart 4).

chart 4

In August we asked businesses a special question aimed at gauging how firms perceive their pricing power, a variation of a question put to the panel last October. Specifically, respondents were presented with a hypothetical, unanticipated rise in unit costs and asked how much of that cost hike they would likely pass along to their customers. The panel was randomly divided into two groups—one was given a 2 percent unit cost increase and the other a 6 percent unit cost increase. According to respondents, most of the unanticipated cost increase would translate to higher prices for customers. On average, firms facing a 2 percent cost increase said they would pass about 1.3 percentage points on to their customers. For those facing a 6 percent cost hike, the pass-through, on average, was a relatively comparable 3.8 percentage points.

Several manufacturers and retailers expressed concern over the ripple effect of the drought on the corn crop, which could lead to price increases on top of an environment where consumer spending has already weakened slightly.

Positive but subdued activity by sector
Most contacts in the retail sector noted positive, but generally slower, sales growth. Reports from the restaurant industry, in particular, were less encouraging. Discount retail operations performed somewhat better than traditional department stores. Luxury goods merchants remained largely positive, although their reports were less positive than earlier in the year. Sales expectations for most retailers remained conservative. Auto sales continued to grow at a solid pace, and dealers anticipated continued strong results.

Hospitality contacts reported strong hotel occupancy and room rates, and convention bookings showed continued strength. Cruise line results remained below expectations. However, contacts in that sector anticipate stronger business in 2013. Florida contacts noted a drop-off in tourism activity from Europe, but that was being largely offset by an increase in visitors from South and Central America.

Manufacturing activity was mixed. The August Southeast Purchasing Managers Index published by Kennesaw State University rose 1.5 points, an increase to 50, a reading that reflects a stable factory sector neither expanding nor declining (see chart 5). The August increase was based primarily on a better reading for production, which rose 5.5 points to 50.8, and employment, which increased 3.1 points to 53.1—a result that may bode well for hiring in the region's manufacturing sector. All of the Southeast's components were below their six-month averages, and only one in four survey participants anticipated that production would increase from current levels over the next three to six months—similar to July's result.

chart 5

Our contacts in Louisiana and Mississippi reported that the impact of Hurricane Isaac on the energy and transportation infrastructure was very minor and port facilities did not suffer any damage. A broader comment on energy: contacts in this sector reported that near-term potential was being limited by infrastructure and labor constraints.

Construction-related manufacturing firms cited a bit more optimism since the last Southeastern Insights report, crediting recent improvements in several housing market indicators.

Positive news from housing
Recent data and reports from housing contacts confirmed that regional real estate activity was improving. Home prices are also improving, though not evenly across all markets. Declining inventory has led to upward pressure on prices, especially within the most desirable markets and submarkets. As inventory diminishes and prices trend upward, the investor share of the market is beginning to dwindle. Demand from current homeowners is starting to improve the most while demand from first-time homebuyers, who are still finding it difficult to obtain credit, has remained flat. Though there are clear signs that the housing market is recovering, we maintain a cautious optimism because the recovery remains uneven and fragile.

The Atlanta Fed's poll of regional brokers and homebuilders indicated that home sales remained ahead of the year-earlier levels in August (see chart 6). Both builders and brokers indicated that home inventories continued to decline on a year-over-year basis. Most builders and brokers reported that home inventories were unchanged from July to August. The majority of D6 brokers and homebuilders reported that home prices increased on a year-over-year basis, which follows the national trends in several home price indices.

chart 6

By Mike Chriszt, a vice president in the Atlanta Fed's research department, and Shalini Patel, a senior economic research analyst