The Federal Reserve, our nation’s central bank, is the most important player in the economy right now. It has been jacking up interest rates to slow down inflation, and it looks like it will continue doing so next week. Everyone’s guessing how much.
Last week, the Federal Reserve released the September edition of the Beige Book. This is a good place to look for clues about what the Fed might do.
The Federal Reserve is headquartered in Washington, but it also has 12 regional banks. North Carolina is in the Fed’s 5th District, and our regional bank is in Richmond. The Beige Book is a district-by-district look at economic conditions around the country, published eight times a year. It is compiled by researchers in each district who talk to business folks about how things are going.
The reason the Beige Book is important is that researchers are getting a recent look at conditions, and so while it is anecdotal, the insights are pretty up to date. While we will get August consumer price index data Tuesday, if you are the Fed decision-makers, you want as much information as you can get, qualitative as well as quantitative.
I wanted to look at what changed between the Beige Book in July and last week’s. The big question facing the Federal Open Market Committee – made up of Fed governors and some of the regional bank presidents – is whether four interest rate hikes this year have started to get on top of inflationary pressures that began accelerating 18 months ago. For a nation that had gotten used to 1-3% inflation, June’s 9.1% year-over-year consumer price index number was something we hadn’t seen in more than 40 years. There was a sense that maybe the Fed had waited too long coming out of the pandemic, and now it would have to just keep raising interest rates until the economy cried uncle and went into a recession, which is what happened under Paul Volcker’s Fed in the early 1980s. It was painful.
Looking for nuance
When the Fed researchers in the districts write their Beige Book sections, they write with nuance. You have to pay attention to often-slight wording changes to get a sense of trends they are seeing. So I went through the 5th District section in the past two books and compared them. Here are changes I saw from July to September:
Labor markets: In the September book, researchers said “employment grew strongly.” The July wording was “employment grew modestly.” In the September book, firms were paying “off-cycle wage increases.” In July, firms were just described as increasing wages. So now, evidently, workers are getting raises between annual reviews, because employers are worried they’ll leave otherwise. From the Fed’s standpoint, this isn’t encouraging. If the labor market is continuing to be this tight – the July jobless rate was 3.4% in North Carolina and lower in more than half the states – then maybe more jumbo interest rate hikes are needed to slow the economy. In both books there was identical language, that employers expected to keep hiring for the next six months. But in the September book, there was, at least, a sense of clouds on the horizon: “An increasing number of contacts mentioned concerns about a possible economic downturn . . .”
The August state-by-state unemployment numbers come out Friday, which will give the FOMC some more visibility into regional labor markets.
Prices: In July, manufacturers were seeing “moderation in input price growth.” By September, input price growth for manufacturers “was flat.” So that’s good. In July, the service sector was seeing “some flattening in output price growth” but in September, firms in both the manufacturing and non-manufacturing sectors reported “a slight uptick in the rate of price growth for their goods and services.” So, they are able to raise prices.
Some different wording in the September book was: “One manufacturer added that not only were raw material prices rising, but so were the prices they pay for business-to-business services.”
Manufacturing: One September change described “improving, but still strained, supply chains as order backlogs and vendor lead times both decreased.” In July, the picture looked worse: “[S]upply chain frictions persisted” and “Backlogs persisted while vendor lead times remained extended,” Maybe supply chains are doing better, which could help lower inflation.
Ports and Transportation: In the July book, the ports were described as experiencing “record volumes, with imports far outpacing exports.” In the September book, “shipping volumes weakened slightly this period.” “[R]ecord numbers of empty containers leaving the ports” in July became, in September, a “steady volume of empties leaving the ports.”
In July, trucking companies reported that “demand remained strong, but there were signs of expanding truckload capacity.” By September, trucking companies were saying that “demand had slowed and the number of booked orders had decreased, but they were not struggling to find loads as customers were still having issues with supply-chain inventory backlogs.” Truckload capacity was expanding, and spot rates were down 30% since spring, although less-than-truckload shipping rates were unchanged. More than 70% of freight, by weight, moves by truck in our economy, so this could be viewed by the Fed as a sign that inflationary transportation bottlenecks are easing and we can, maybe, avoid Volcker II.
Retail, Travel and Tourism: In the July book, retailers reported that sales had started to decline slightly, and rising costs were reducing consumer demand. In September, retailers were reporting “little to no change in revenues and a slight softening of consumer demand in recent weeks.”
In July, hotels were saying that occupancy and average daily rates were increasing. But the September book, which researchers were putting together as late as Aug. 29, said hotels were giving “mixed reports.” A hotel in North Carolina said occupancy rates were lower in July than a year ago, which was the first time in 2022 that occupancy rates were lower year over year. But their average revenue per room was higher, and future booking remained strong.
According to the September book, business air travel “reportedly picked up” and a port contact reported “strong demand for leisure cruises.”
Real estate and construction: In March, concerned that inflation was continuing to rise to around 8%, year over year, the FOMC started raising interest rates, a quarter point at first, then half a point in May. In June and July, the hikes were three-quarters of a percent each time. The increases boosted mortgage rates, and the 30-year fixed-rate mortgage, which was below 3% a year ago, started climbing. It is now nearly 6%, according to Freddie Mac. This had predictable results in the residential real estate market. The July Beige Book said that in the 5th District, contacts were reporting “a shift in market activity to slightly lower sales volumes and a reduction in buyer traffic.” Inventories of homes for sale and days on market increased, while the growth in listing prices started to soften. In the September book, this trend continued. “Demand remained strong, but it was noted that affordability was an issue as some buyers no longer qualified to purchase a house due to elevated home prices coupled with increasing mortgage rates.”
In the commercial sector, activity went from “strong” in the July book to “stable” in September. Office and retail market activity “was starting to slow” in the September book, “while industrial or multifamily segments continued to experience strong leasing demand, low vacancy rates and increasing rental rates.” District-wide, the September book said, there is a shortage of Class A office space, “especially in suburban markets, and the amount of sublease space had been shrinking.”
This varies from city to city, and report to report. I have seen a report that Raleigh-Durham had a 12.5% office vacancy rate in the second quarter. I have seen another report that put Raleigh-Durham at 16.8% and Charlotte at 18.3%, while Charleston and Columbia are significantly tighter. Companies are still sorting out remote work and how that will impact office requirements.
New commercial construction projects “decreased slightly due to higher construction costs, lack of availability of some materials and increased interest rates,” according to the September book. Interest rates and construction costs were not mentioned as factors slowing down new projects in the July book. The problem was getting materials and skilled workers.
Banking and Finance: In July, deposit growth was mixed. Some banks saw slowing because consumers were being hit by rising prices; some were seeing deposits grow because a volatile stock market was causing a “flight to safety.” By September, deposit growth was flat, even though banks were increasing rates. In July, loan delinquencies were low. By September, some institutions said delinquencies were increasing slightly, mainly consumers. But overall borrower credit quality “remained good with no signs of deterioration.”