A Happier New Year?

Southeastern Insights
December 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 October 25 to December 12.

With so much of the current narrative on the economy dominated by the fiscal policy debate, we really did not anticipate much change in what we would hear from our business contacts in November and December. After all, we have been told by our contacts for some time that fiscal policy uncertainty was one of the main factors behind their apprehensive outlooks for their businesses.

Nonetheless, we detected an unexpected increase in optimism among business contacts over the past seven weeks. Among our directors (35 from our branch offices and nine from Atlanta), just under half expect their businesses to improve over the next three to six months, compared to just one in four in October (see chart 1). That said, our directors—in fact, all of the businesses we reached out to in recent weeks—indicated that they have plans on the drawing board to react to circumstances in Washington surrounding the fiscal cliff negotiations, which suggests that the impact on the short-term performance of the regional economy could be significant.

chart 1

In our conversations with business leaders, there was only limited evidence that this apparent shift in optimism was translating into concrete moves to increase payrolls to date. Hiring plans remained most notable in energy, information technology (IT), health care services (except for hospitals), and some manufacturing sectors—namely, auto-related producers. Yet October's employment data seemed to show some momentum building in the region.

The U.S. Bureau of Labor Statistics reported on November 20 that the Sixth District states added nearly 60,000 jobs in October—the strongest monthly increase since October 2010—and the region's unemployment rate fell to 8.3 percent, the lowest reading since December 2008. Perhaps more importantly, October's positive numbers are a marked improvement over the soft labor market readings of the spring and summer months.

October's gains were broad-based in geographic terms as all southeastern states added jobs. The largest increase was in Georgia at 16,100, with Florida next at 14,700, and Louisiana with 12,200 (see chart 2). Louisiana's increase was the largest in percentage change terms (+0.6%), and the Bayou State also had the largest decline in the unemployment rate among regional states, at -0.4 percentage point (see chart 3).

chart 2

chart 3

Regional employment gains were broad-based by industry; all sectors added jobs in October. Trade and transportation employment rose 13,500 for the region, while private education and health care increased another 12,600 (this sector continued to add jobs throughout the recession). Construction, by far the hardest-hit industry during the recession, added 2,300 jobs in the region.

While all this is certainly good and welcome news, we're going to keep the champagne on ice for a number of reasons. First, one month's data do not make a trend. Along those lines, a look at the three-month moving average of regional job growth shows that we've had similar increases in job growth in the years since the recession officially ended. The jump in 2010 was boosted by temporary census-related hiring, and in the first few months of 2011 and again in late 2011 into early 2012, we saw encouraging increases in employment only to be followed by periods of disappointing results.

Simply said, while increases in employment and declines in the headline unemployment rate are good news, these increases need to be sustainable. As Atlanta Fed President Dennis Lockhart said in his November 1 speech in Chattanooga, Tennessee, he is looking for "substantial improvement" in the labor market, but one month of data is not enough to demonstrate that. Improvement in other labor market indicators is also essential, such as increased flows of job seekers into the labor market, resulting in an increase in the labor force participation rate; employment gains that are associated with reductions in underemployment; and forward-looking indicators of labor market health such as falling claims for unemployment insurance. In addition, we would need to detect a shift in sentiment among our business contacts that would point to stronger hiring trends than we are seeing now.

While the increase in optimism we picked up on of late may or may not be translating into a surge in overall hiring, there are some sectors where we do see growing employment momentum (see chart 4). Some specific examples include reports of improving activity in residential construction, where regional employment has increased over 2 percent over the last three months. In addition, it is clear from our discussions with builders, contractors, and suppliers that many firms with ties to this sector are positioning themselves for additional growth in 2013. Business services has also posted strong gains over the past several months, as has retail employment.

chart 4

The fact that we are seeing improvement in regional construction employment confirms what we have been hearing from our contacts in the real estate sector: housing continued to build momentum late in the year. For example, in early November, we met with Gulf Coast real estate contacts in Pensacola, Florida. The majority of those contacts noted that home prices had hit bottom, and they expected home price appreciation to continue to be flat to slightly up through spring 2013. Balanced home inventory levels, fewer distressed properties, more buyer traffic, and increasing home sales all contribute to this dynamic, they said.

These themes were not limited to the Gulf Coast. Many larger regional homebuilders noted that they have moved from a defensive stance to an offensive one. More broadly, our October poll of homebuilders indicated that regional construction activity was ahead of year-ago levels, and the outlook for construction activity next year continued to improve. Southeastern housing contacts continued to report sales gains in October (see chart 5). Brokers indicated that sales remained slightly ahead of the year-earlier level while builders reported that sales growth rebounded in October. Both builders and brokers continued to report declining home inventories on a year-over-year basis. Most contacts said that home prices increased in October, indicating that prices rose modestly compared with a year earlier.

chart 5

The outlook for sales among Southeast builders and brokers remained positive as well (see chart 6).

chart 6

In our recent housing polls, we also asked southeastern brokers and builders about the availability of mortgage financing for home buyers in their markets. Builders indicated that accessing finance for construction development remained challenging. Most builders reported that available credit fell short of demand.

More broadly, small business loan demand increased slightly in some areas, but many firms remained hesitant to borrow, citing economic and political uncertainty as a drawback. Financial institutions were largely more positive than we've heard for quite some time. According to our contacts, more entities are seeking credit—though competition for good loans is still fierce. Feedback also indicates slightly more willingness on behalf of the lenders to increase their tolerance for risk. Auto lending remains active as well. Commercial activity was described as tepid but with some improvement, especially among energy, health care, technology, and consumer product businesses. Regulatory compliance was cited as adding an additional burden by many community bankers, which hampered their ability to originate loans. One area of employment growth in this industry is with compliance staff as they work to meet new regulatory requirements.

Energy-related activity continues to grow
Here's another twist on construction employment. In our discussions with contacts in the energy sector, they raised concerns about finding construction workers for the growing number of energy-related plant expansions that are on the drawing board. From refineries to petrochemical operations, the number of firms that are positioning themselves to take advantage of the growing availability of natural gas and other energy resources is rising significantly. All energy-related contacts are concerned about being able to fulfill capital expansion projects because of the scarcity of skilled construction workers.

Supporting the view of industry contacts was Professor David Dismukes, associate director of the Center for Energy Studies at Louisiana State University. Dismukes noted in conversations with Atlanta Fed staff that the United States is entering an energy renaissance period and that the United States—and North America generally—has quickly become one of the most attractive regions for new investment. Dismukes also believes that the effect on hiring will be significant as the energy infrastructure expands, and there will also be considerable economic development opportunities through lower energy costs.

Regionally, the impact of the energy boom would likely be felt most directly in Louisiana, where most of the Southeast's energy infrastructure is located. But the longer-term implications of affordable, abundant, and diverse sources of energy could be significant for the rest of the region and the country as a whole.

Manufacturing takes a pause
Apart from energy-related activity, it appears manufacturing has cooled a bit, although factory employment was still up nearly 2 percent year over year in October. The Southeast Purchasing Managers Index, which is compiled by Kennesaw State University's Econometric Center, dipped below 50 in October (a reading above 50 represents an expansion in manufacturing, below 50 indicates contraction) and remained lower than 50 in November (see chart 7). The new orders component of the index also came in below 50, which is a concern, as this index component typically serves as a leading indicator for manufacturing as a whole. That said, 31 percent of survey respondents expect production to be higher in the next three to six months versus 29 percent for October. The outlook index is 52.7, indicating that more survey participants anticipate improvement in the short term.

chart 7

Contacts in the auto manufacturing sector remained optimistic, and several noted that they are producing at levels above prerecession operating rates. There were reports of supply constraints from this sector as well, and contacts expressed concern that future growth was in danger of being impacted by some suppliers' reluctance to expand capacity to meet anticipated order growth.

Holiday spending holding up
Early reports from retailers were positive, although initial enthusiasm for a robust holiday shopping season tempered a bit after the strong results from Thanksgiving weekend. Inventories appear to be on target, but margins continue to be strained due to discounting. Seasonal hires were reported to be comparable to last year. Expectations for the remainder of the holiday season were that sales would be slightly above last year's.

Travel and tourism activity remained strong for all sectors except cruise lines, which continued to underperform against projections made earlier in the year. Hotel occupancy and room rates were up in most areas, resulting in increased revenue per available room. International visitors continued to bolster activity in Florida. December is a peak travel time for the central Florida area and its theme parks, and increased international service was expected to give the area a boost this month. Area attractions continue to invest significantly in park enhancements. Convention bookings were also up over year-ago levels in most major cities.

Prices in check, but concerns going forward
We also continued to hear from contacts how the litany of cost-related uncertainties—taxes, regulations, health care—were downside risks to their outlooks for 2013. This could have important implications for labor markets. Even if the economy picks up steam in 2013, firms may remain hesitant to hire full-time staff because of the perception that nonwage labor costs will be higher going forward, coupled with an inability to predict labor (especially benefits) costs.

On prices, the inflation expectations of businesses in the Southeast for the coming year rose to 2.1 percent in November, up from 1.8 percent in October, according to our most recent business inflation expectations (BIE) survey.

Wage pressures remained largely in check, apart from some IT, manufacturing, and energy-related positions. That said, information from our survey showed that expectations for price increases resulting from labor costs over the next year rose in November, with the average likelihood of moderate to strong upward pressure in labor costs rising from 58 percent to 62 percent. The costs associated with the Affordable Care Act in 2013 remained a concern for businesses.

Looking ahead
The main question heading into the new year is, will many of the emerging signals that point to increased optimism and improving activity in several sectors lead to stronger economic growth overall and better outcomes for the labor market? We'd be going way out on a limb to say yes, but at the same time, it would be prudent to acknowledge that the regional economy is showing some upside risk potential.

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