Southeastern Insights

Southeastern Insights
March 2012

We are introducing a new report from the Federal Reserve Bank of Atlanta as part of the Bank's Regional Economic Information Network (REIN). The report is called Southeastern Insights and represents the sum 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. As such, this report covers the period from the meeting that took place January 24–25 to the meeting held March 13.

REIN intelligence is delivered to Atlanta Fed President Dennis Lockhart throughout the FOMC cycle. Specifically, there are two periods during the FOMC cycle when we make formal presentations—one occurs midcycle to coincide with the release of the Beige Book report and the other takes place the week before the FOMC meeting.

Our regional executives, who operate out of the Atlanta Fed's six locations and are the primary gatherers of business intelligence, present at these meetings and participate in other meetings designed to keep President Lockhart informed of regional economic developments. We also incorporate input from our Branch Board of Directors meetings as well as guidance from the Atlanta Board of Directors.

The most recent mid-FOMC cycle presentation reflected the latest Beige Book report, which noted that Sixth District business contacts described economic activity as expanding at a somewhat stronger pace in January and early February compared with late last year. Expectations were generally more positive, although firms continued to express caution with regard to the outlook.

In our end-of-FOMC cycle report to President Lockhart, our assessment generally reflected a similar view. The optimism we noted earlier in the cycle continued, and businesses appeared to be adjusting their business plans to the improved outlook. Several firms noted plans to add to their workforce, increase capital investment, and adjust inventories—all to match the real or expected increase in demand. We also polled Atlanta Fed and Branch directors on their overall take on current and expected economic activity. In early March, roughly four out of five directors reported they expect economic activity to improve over the next six months compared with the previous six months.

Labor markets
While there is growing optimism expressed among contacts, it is important to recognize that businesses are approaching expansion plans with caution. For example, while many businesses are adding to payrolls, we continued to detect hesitancy on the part of firms to increase the size of their workforces. While they may be adding employees, temporary or contract hires continue to be favored by many firms as a means to address labor needs. More companies are hiring temporary or contract workers as part of a vetting process before adding them formally to their payroll. Most smaller businesses appear to be looking to rebuild margins before moving to adjust their workforces. Businesses also continue to weigh carefully all decisions that increase costs. So, even though economic performance and the business outlook may be improving, that improvement may not immediately translate into additional hiring for most firms—at least in the short term.

We also continue to receive feedback about the lack of qualified labor in several industries. For example, to meet their labor needs, some firms are holding job fairs—some well outside their bases of operations—to attract talent, and they are bringing back retirees on a contract basis to help train new workers hired without the requisite skills.

Concerns over increased input costs were shared by many of our contacts. Several firms noted an increase in some commodity prices and, of course, fuel prices. Increased transportation costs are being passed along to consumers without much difficulty.

Businesses also expressed more concern about a potential rise in labor costs.

We are not picking up much in the way of shifting inflation expectations from the Atlanta Fed's survey on Business Inflation Expectations. The latest results indicated that, on average, survey participants expect unit costs to rise 1.9 percent over the next 12 months. That number is up from 1.8 percent in January.

Although most contacts reported having little pricing power, during this cycle we did hear more reports of firms that were at least partially successful in passing along some or all of their input price increases to consumers.

We also picked up on some growing concern about price increases down the road, if upside risks to economic activity are realized. Some businesses that have been suffering from margin squeeze want to raise prices, but most firms do not feel they have the pricing power in the current environment. If the economic recovery accelerates and demand begins to pick up noticeably, the concern is that businesses may react quickly and raise prices fairly rapidly.

Our contacts remain concerned about increases in energy prices. While fears of a credit event in Europe affecting financial markets here have abated somewhat, the risk is not off our contacts' collective radar. We're also detecting less anxiety about fiscal policy uncertainty, but again, it's still on the radar for some firms. Contacts' main concern, by far, is the potential for an energy price spike tied to geopolitical developments in the Middle East.

Consumer spending
Most reports on consumer spending were generally positive. Sales of home appliances, furniture, and autos were noted as being especially strong. However, the general feeling among our contacts was that a good deal of recent consumer activity was the result of pent-up demand.

That information appears to run counter to our latest informal poll of retail contacts, who were slightly more subdued. Fewer merchants reported an increase in sales than in the previous report, and sales expectations were a bit more moderate. There was also little improvement evident from the question on sales levels compared to “normal” times in the Business Inflation Expectations survey. Recent retail sales data have been positive, so it's likely our surveys were picking up on a bit of a holiday letdown that turned around in February.

Surveys from other regional sources point to an improving consumer outlook. Middle Tennessee State University's consumer confidence index rose sharply in late January, reporting the highest level for the overall index since February 2008. The survey foresees a trend among consumers simply to hold steady with their level of spending.

Business sentiment measured by the University of Alabama's Business Confidence Index™ improved to 50.8 for the first quarter of 2012, up 5.3 points from last quarter's 45.5. The university found that panelists are generally feeling mildly optimistic about their prospects this quarter.

However, consumer confidence among Floridians dropped one point in February from January, to 76, according to a University of Florida survey. The modest decline followed two months of rising levels of confidence in the economy.

One area where spending has remained robust in the Southeast is travel and tourism. Hospitality contacts reported that tourism activity remained strong and most were optimistic regarding the outlook for leisure and hospitality spending in 2012. Attendance for major conventions increased, and bookings and volume rose, according to business travel contacts. However, there were concerns about higher fuel costs and the adverse impact it may have on drive-to regional tourist destinations.

Housing markets continue to recover gradually in the region. The Atlanta Fed's informal poll of regional builders and brokers indicated some sales growth. Nearly two-thirds of brokers reported sales gains, and more than two-thirds of builders also reported that sales were up slightly compared with a year earlier.

Unfortunately, home prices in the region continue to languish, although there was some positive news from brokers. Southeastern broker reports indicated that downward home price pressure abated during January. Among brokers, roughly one-third said that home prices were up year over year, but the rest reported stagnant or declining prices.

The Atlanta Fed's Center for Real Estate Analytics reported that though down from the peak level, the percentage of mortgages that are seriously delinquent continues to be elevated. Prices of nondistressed sales and the cost of owning versus renting have stabilized. However, the impact of the large number of distressed properties will likely constrain any broad home price appreciation. In fact, home price indices may continue to fall despite high affordability and stability in housing starts and sales relative to historical trends.

Of particular note, our poll results show that sales expectations among both builders and real estate brokers continued to improve. In fact, builders' expectations are at their highest level in our poll's history. It is important to remember, however, that sales levels are at historic lows as well, so improvement is occurring from very weak levels of activity. But any improvement, especially in the hard-hit real estate sector, is welcome. In addition, the upward trend in multifamily starts reflects expectations for rent growth and the difficulty some consumers are experiencing in purchasing houses.

Contacts in the region remained upbeat. A regional survey of manufacturing activity from Kennesaw State University's Southeast Purchasing Managers Index rose 9.7 points, to 64, in February, driven by a jump in new orders. Our factory contacts generally reported that inventories were at or near desirable levels. Positive reports from automakers continued. Three major auto manufacturers announced plans to increase production at their facilities in Alabama and Georgia, and a foreign automaker also noted that a parts manufacturing facility will relocate to the region.

The Atlanta Fed's Energy Advisory Council met in late February to discuss developments in the energy sector. As expected, members were very concerned about the increase in oil and gasoline prices, and felt there is no immediate solution. Members noted that roughly one-quarter of gasoline used in the United States is developed from domestic resources. Most of the oil that is refined into gasoline comes from abroad. Since the price of imported crude—known as Brent crude (the global crude oil benchmark)—is higher than West Texas Intermediate crude (the U.S. benchmark), retail gasoline companies are pricing their products using Brent rather than West Texas Intermediate. Members noted that Brent crude has been more vulnerable to geopolitical pressures since it is global in nature and therefore is experiencing a drive-up in price.

Energy Advisory Council members noted that infrastructure needs to be developed to process oil imported from Canada. The members also reported that domestic shale is producing oil, but these products tend to be better suited as an input for the chemical industry rather than the motor fuel industry.

Looking ahead
We are cognizant that last year at this time we were receiving reports that were not wholly dissimilar to what we are picking up now from our contacts. Atlanta Fed President Dennis Lockhart noted this point in a February speech in Florida:

In the first four months of last year, the payroll measure of employment growth averaged over 200,000 jobs per month. But then came a late-spring/summer "swoon" during which that payroll number never exceeded 100,000. From April to August, the unemployment rate stopped declining, and the economy grew at an anemic pace.

So what should we make of the recent good news? Are recent improvements in the incoming data a sign the economy is gaining traction?

I'm pretty confident it is. There's always a caveat, however, and the caveat is "in the absence of shocks." The story of 2011 was one of shocks. There was a run-up in oil prices as a result of the Arab Spring. Commodity prices also rose rapidly for a variety of reasons. The earthquake and tsunami in Japan and the floods in Thailand disrupted global supply chains. The European debt crisis and the U.S. debt ceiling impasse shook confidence.

At this time, the increased level of activity and rise in optimism among our business contacts seem to be confirmation that the economy continues to improve at a moderate pace. Of course, the potential for a shock tied to energy prices weighs on our contacts' minds as well. That concern represents a significant downside risk to the outlook for continued moderate economic growth. As President Lockhart said further in his speech,

Significant unanticipated developments are part of economic life, but barring shocks, we at the Federal Reserve Bank of Atlanta expect 2.5 to 3 percent growth for 2012.

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