Timidity Persists, but Better Signals Emerging

Southeastern Insights
October 2012

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 September 14 to October 24.

Last month in Southeastern Insights we wrote that information gathered from the business community in August and early September showed that the expansion of economic activity remained positive but slow. The apprehensive nature of activity continued through late October, and most contacts expect little change in the near term. Several contacts described current activity as "drifting sideways" with only marginal growth in most areas. Weak demand and uncertainty continued to be cited as two reasons for the slow pace of expansion. These uncertainties focus on the durability of the recovery (expected demand) and future health care, tax, and regulatory costs.

While weak demand was the most frequently cited reason for soft growth expectations going forward, the theme of "bigger is not better" persisted in October. Many contacts stated that business expansion is simply not worth the risk in the current environment, and the focus is all about profitability. We received several reports of companies running at full capacity and experiencing growth in sales but choosing not to take on the risk of investing for expansion, and several business contacts reported postponing planned investments until 2013. The health care industry is an exception to this trend, as it continues to prepare for the influx of patients as a result of the Affordable Care Act.

There was not much change in our directors' (from the Atlanta Fed Board and our five branch boards—44 directors in total) outlooks for their businesses in October compared to September. Although the majority of directors said they expect growth in their businesses to be unchanged from current levels, the percent that expect slower growth increased. One in four directors expects growth to improve (see chart 1).

Looking ahead, our directors expect growth to accelerate. The driving forces behind this anticipated improvement are fairly straightforward, as most believe demand will accelerate and current uncertainties will fade. Still, one in three directors does not see much improvement from current levels of activity (see chart 2).

While the timid economic expansion relented, some bright spots continued—namely, more positive momentum was seen in the housing sector. While improving sales and an increase in building activity are welcome, we remain cognizant that these increases are coming off historically low levels of activity.

The majority of Southeast builders described home construction in the third quarter of 2012 as up slightly compared with a year earlier. Single-family permits measured year to date were up 18 percent in the region compared with a year ago, driven by activity in Florida (up 24 percent) and Georgia (up 23 percent) through August.

Builders reported that finished lot inventories were mixed across the Southeast, but most builders anticipate finished lot inventories to shrink over the next six months. The outlook among homebuilders for construction activity over the next several months remained positive, with most contacts anticipating activity to be flat to slightly up compared with a year ago.

Mixed signals emanated from the manufacturing sector. Manufacturing activity rebounded in September, according to the Southeast Purchasing Managers Index (PMI) produced by Kennesaw State University. The survey also detected a surge in new orders. However, electricity sales to manufacturers dipped, according to utility contacts, but some of that drop-off may be a result of factories using cheaper natural gas for some operations. Auto production remained positive as well. Energy-related activity—from manufacturing and refining to exploration and extraction—continued to do well. This sector is also experiencing significant capital investment in both upstream and downstream activities.

We received some mixed signals from the retail sector, too. While reports on current and expected activity remained rather subdued, retail trade shows have seen solid attendance and were reporting improved orders for goods. That being said, transportation and retail contacts expect the holiday season to be similar to last year with focus continuing to be placed on limiting inventory buildups. Tourism contacts reported solid activity in the early fall, but they are concerned about the impact of higher fuel costs and the potential adverse impact on bookings from international visitors resulting from weaker global growth, especially in Europe.


The region's unenthusiastic labor markets
Any notion that an increase in some positive but weak signals on economic activity was resulting in increased hiring was not supported by our conversations with business contacts over the past month. Employment levels have been largely steady with few firms in the region anticipating significant hiring in the near term. Most companies reported very little hiring other than replacing employees because of turnover. Businesses continued to pursue productivity enhancements that will allow for some level of growth without adding to head count. Several companies noted that acquisition activity is resulting in a net reduction of workers as back office jobs are consolidated, but overall our business contacts do not have widespread plans to cut payrolls because of soft economic activity.

Reports of hiring appear to be limited to industries such as auto manufacturing, information technology, and accounting. Both health care and tourism hiring reports were not pessimistic, although the pace in tourism hiring has recently slowed slightly. Some agriculture contacts noted that their industry is currently experiencing a shortage of workers to support the harvest season.

The most recent official data on employment were uninspiring. Net payroll for the Sixth District was +6,900 in September. That was a result of gains in five of the six district states. September's gain in payrolls was much less than August's gain of 24,000, but August's strength mostly came from Florida. The unemployment rate declined for five of the six district states, with Mississippi being the only exception.

To give these monthly data some perspective, see chart 3, which shows job losses during the recession and job gains during the recovery by state in percent change. The bottom line is that while job growth has been positive, southeastern states have a long way to go to reach prerecession employment levels.

Chart 4 tracks the progress of individual regional state unemployment rates since 2011. The momentum of declining unemployment rates that began in 2011 and early 2012 was lost in mid-2012. More recently, unemployment rates have begun to decline again in most states.

Reports of skills mismatch of employees persisted in the last FOMC cycle. Several manufacturers reported challenges finding entry-level workers for assembly lines, despite offering highly competitive starting salaries. Several firms reported some increase in wages, driven by the need to attract already employed workers away from their current jobs. However, many companies across several sectors have not significantly raised salaries to attract employees—they would rather train a candidate on the job in order not to raise wage expenses. Some companies have engaged in an advanced screening process to help identify qualified workers and minimize turnover. Staffing challenges in the mortgage lending market will continue to restrain home lending activity, according to several banking industry contacts.

Inflationary pressures at bay
Controlling costs remains a central theme for businesses in the Southeast. Higher energy and crop-related input prices along with continually rising health care costs are a large part of this challenge. That said, the feedback we have received from firms throughout the region is that the pressure from input prices overall has eased over the last several months. While energy and agricultural goods prices are important because they touch most firms, we are not currently seeing widespread input cost pressures.

The Atlanta Fed's most recent survey on business inflation expectations, which includes responses from nearly 200 businesses in the Southeast across a wide range of industries, illustrates this broader view. Despite reports of higher fuel and food input costs, firms reported that their unit costs were up just 1.4 percent on average compared to this time last year. That number is below their October 2011 year-ahead expectation of 1.9 percent. Looking forward, respondents indicated that, on average, businesses expect unit costs to rise 1.8 percent over the next 12 months. That number is up slightly from 1.7 percent in September, but still somewhat below recent year-ahead inflation forecasts of private economists.

According to the businesses surveyed, firms continue to operate in an environment of below normal sales levels and profit margins. Projecting ahead, firms continue to anticipate little or moderate upward pressure coming from input costs over the next 12 months. Respondents also anticipate that margin adjustments and sales levels are likely to have a small upward influence on the prices they charge in the coming year.

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