Steady As She Goes?

Southeastern Insights
June 2013

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 May 2 to June 19.

General conditions
The outlook among our business contacts was largely unchanged since our last report. When queried about their near-term outlook (the next three to six months), 55 percent of Sixth District directors said they anticipate a higher rate of growth in their businesses, a slight increase from April (see chart 1). One contact characterized the prevailing sentiment as "businesses are more confident in their outlook, but their outlook hasn't changed [in the last six weeks]."

Chart 1 Outlook for growth rate of business 3 to 6 months

Real estate
One industry that continues to experience moderate to strong growth is real estate. We are beginning to hear more reports that the housing recovery is having a positive impact on businesses such as site developers, construction companies, home furnishings outlets, and insurance firms. Also, banking contacts tell us that traffic for mortgages is picking up (see chart 2) and that the appetite for investment is increasing among both retail and institutional investors.

Chart 2 Mortgage loan applications

However, the strength we've seen in multifamily development is causing some to watch this sector carefully. Cap rates for high-quality commercial real estate projects are at low levels, and some contacts have expressed concerns that these real estate valuations may be reaching unsustainable levels.

In other news…
The banking environment remains highly competitive. Banks continue to find ways to aggressively capture high-quality loans, yet credit availability remains a challenge for smaller companies and residential builders. Nonetheless, reports indicate that nonbank lenders are entering the market to provide much-needed capital for these smaller companies.

Although creditworthy contacts note that traditional financing is very attractive, businesses remain reticent to "pull the trigger" on new capital projects to expand capacity, preferring to set the stage by lining up financing for future expansion but holding off on execution. What business investment there is continues to focus primarily on acquisitions and productivity-enhancing technology to reduce costs rather than expanding capacity, as there continues to be relatively low levels of organic growth coming from increased demand.

On the manufacturing front, businesses tied to heavy industrial production or infrastructure construction have not been optimistic. Expectations are for a flat second half of 2013, which should be no surprise given the slowing that is showing up in the Southeast Purchasing Managers Index (see chart 3).

Chart 3 Southeast PMI

Employment: An interesting mix of stories
Overall, our contacts report subdued levels of hiring (see chart 4) and wage increases in the range of 2–3 percent. However, there are some interesting stories that feel new and different from what we have heard in the recent past. We are beginning to hear reports of increased turnover in sectors such as health care, manufacturing, and technology because there appears to be improved confidence about job-finding opportunities. Furthermore, employees who had been thankful to have a job during the downturn and were therefore reluctant to ask for concessions from employers, are becoming more vocal about obtaining improved wages and are indicating a willingness to change employers to get it.

Chart 4 Contributions to change in net payrolls by Sixth District state

At the same time, businesses have continued using staffing models with greater reliance on temporary and contract workers. However, this cycle, we heard a report that a company was converting its best contractors to permanent staff to keep from losing them. There also appears to be an emerging phenomenon whereby an increasing number of workers are seeking part-time employment by choice, primarily in high-wage service industries. Granted, these reports seem to be limited to relatively high-skilled labor and the majority of contacts aren't planning significant hiring, but taken together, these reports do seem to indicate improving labor confidence, which may explain the uptick in May's labor force participation rate (see chart 5).

Chart 5 Unemployment and labor force participation rates

In general, our contacts were not highly concerned about most of their input costs, which remain relatively stable. Some businesses feel that lower input prices are providing some needed breathing room for profit margins, as demand in many areas is not providing revenue growth.

However, costs related to construction materials such as lumber, concrete, and drywall did increase for some of our contacts. A few of the stories in this realm were quite instructive—rapidly increasing costs are making it difficult for estimators to price out construction projects accurately, but in other dimensions, prices are declining (an example is steel; see chart 6). This is creating an incentive for some manufacturers to work through their metals inventory so that they can resupply inventories at lower prices.

Chart 6 Spot CPI: all commodities

Where input costs are rising, we see little evidence that the increases are being passed on to consumers. Our business contacts continue to report having very little pricing power. At best, some large and more sophisticated businesses are attempting to improve revenues by reducing discounts or altering other terms of sale, but for the most part, they are not seeking straightforward price hikes.

Consistent with our earlier observations about some signs of improvement in the labor market, the results of our May 2013 Business Inflation Survey show that 65 percent of respondents expect labor costs to put moderate to strong upward pressure on prices over the next 12 months, the largest percentage since the survey began in October 2011.

Headwinds and risks
As for headwinds, because incomes are not rising significantly, we might have expected reports of deteriorating consumer sentiment. However, that was not the case. Likewise, there were only isolated reports of concerns regarding the effects of the sequestration, and the impact appears to be muted.

Looking ahead
As the housing recovery continues, there has been an improvement in the level of confidence in near-term projections of slow but steady growth. Yet businesses remain cautious (especially with respect to hiring), even though concerns about downside surprises seem more remote than they have in recent years. Many important questions remain: How long can consumers sustain spending in the face of modest income growth? When businesses get ready to hire, will they be able to find the skilled staff they need? And will low levels of personal consumption expenditures (PCE) growth persist? For now, we see many businesses forging ahead, expecting things to get better slowly, yet preserving flexibility for an uncertain future.

By Lesley McClure, a vice president and regional executive in the Birmingham Branch, and Shalini Patel, an economic policy analysis specialist in the Atlanta Fed's research department