Today’s Beige Book indicated that economic activity across all twelve Federal Reserve Districts continued to expand from late-November through the end of 2017. The Dallas District reported a robust increase in activity while the remaining Districts noted modest to moderate gains over this period of time. Sentiment remains positive and should be amplified this year as the impact of tax reform begin to take effect.
Retailers reported expansion in non-auto purchases, with the holiday season rewarding some more than anticipated. On the other hand, vehicle purchases were mixed across Districts as the boost from hurricane replacement needs dwindled. Increasingly, retailers are implementing technology upgrades and expanding their e-commerce channels in order to remain competitive.
Price pressures largely intensified relative to the previous report, with inputs to manufacturing, construction and transportation experiencing notable cost increases. Some of these increases in non-labor input costs were passed onto consumers by way of selling prices. Retail price increases were modest in comparison, while building material prices remained elevated.
Residential real estate inventories remained tight, leading to consistent growth in home prices. However, the lack of homes for sale restrained home transactions, which were largely flat as buyers were disappointed by the lack of options on the market. At the same time, a scarcity of labor also limited construction activity, with contacts reporting little relief in the near future. Non-residential activity continued to increase, supported by favorable business conditions.
Employment growth continued at a modest pace relative to the prior report, with hiring becoming increasingly complicated by a shortage of qualified workers. Notably, manufacturing and construction workers were in short supply. This led employers to increase wages, with a widening array of industries raising wages since the prior report. Additionally, several firms intend to continue raising wages in the coming months.
Manufacturers largely reported modest growth in business conditions, with capital expenditures increasing for many producers. Transportation activity also rose alongside production. Some auto assembly plants experienced delays in activity as they re-tooled their shops in order to shift focus away from small passenger car production towards SUVs. Importantly, several manufacturers intend to ramp up investment in 2018 as order volumes are expected to rise.
Key Implications
This Beige Book confirms that the economy rounded out 2017 on solid footing. Inflation pressures continued to build, with steady increases in labor and non-labor input costs suggesting that selling prices will edge higher over 2018. Strong demand led several manufacturers to invest in additions to capacity, with this trend set to continue through the year as the effects of tax reform begin to be felt. Specifically, the slashing of the corporate tax rate, along with the immediate expensing of equipment should support investment. Additionally, heightened global economic growth expectations will further add to this positive sentiment. At the same time, the renegotiation of NAFTA is still a lingering uncertainty, and may thwart some investment until a resolution is in sight.
Consumer incomes will continue to reap the benefits of a tightening labor market, with personal income tax cuts further supporting disposable income gains. On the housing side, inventory of homes for sale will likely remain constrained, as the pipeline of new properties is hindered by labor shortages in the construction industry, with price pressures remaining in place. This will continue to stretch affordability and, together with the implementation of the $10,000 cap on state and local tax deductions (which includes property taxes), will also raise the cost of homeownership. Taken together with the lower cap on the mortgage interest deduction (down from $1M to $750k), this is slated to weigh on home price growth in high-priced markets including those in New York and the District of Columbia.
This report suggested that businesses are increasingly passing on increases in their own input costs to consumers. As such, these should show up in headline inflation figures in the near future. Together with a healthy labor market, the pick-up in inflation should enable the Fed to implement three hikes this year, with the first of these likely to take place in March.
