Today’s Beige Book indicated that economic expansion across all Federal Reserve Districts progressed at a modest to moderate pace in July and August. This is an advancement from the last Beige Book that cited a slight to moderate expansion across districts. Despite this, several firms in the path of Hurricane Harvey, along the Gulf Coast, were forced to postpone activity, namely in the production of oil and natural gas as well as fuel refining and petrochemicals.
Household spending continued to be a significant contributor to growth with non-auto retail sales and tourism being key components. The one weak spot continues to be auto sales which have displayed lackluster performance this year after peaking in 2016. Retailors are remaining upbeat, with spending activity likely to remain robust and support economic activity going forward. This will be helped by rising incomes alongside consumer and business loans that were noted as growing modestly in most Districts.
Prices rose modestly with input and materials costs leading the way. Notably, steel, lumber and freight prices rose. However, producers reported that increases in input prices exceeded any rise in selling prices eroding their profit margins.
Low inventory levels of residential property continued to restrain sales and are leading to robust home price gains. However, homebuilding activity increased slightly overall, indicating some relief for homebuyers is on the way after a prolonged period of flat residential construction activity. While higher mortgage rates may further put pressure on activity, this should be offset by rising incomes.
Employment growth slowed on balance, with a slight to modest pace of hiring cited in most Districts. Labor scarcity is increasingly presenting employers with challenges in the recruitment and retention of workers of all skill levels. This was especially prevalent in the manufacturing and construction industries. Despite labor market tightness, the majority of Districts reported limited wage pressures with modest to moderate wage growth. A select few firms in the Dallas and San Francisco Districts indicated that pressures were beginning to push wages up.
The manufacturing sector, which is reported as being one of the two tightest labor markets, looks to be turning a corner, with several firms planning expansions. The weakness in vehicle sales translated into concerns for auto manufacturers, but most other manufacturing industries expanded modestly on balance. Most manufacturers reported that sales had expanded in line with their targets and expectations for future sales were positive. However, capital spending continues to hinge on policy outcomes for some producers. For example, an electrical equipment manufacturer in the Boston District noted that political pressures had led them to reduce offshoring of production, thereby leading the firm to increase spending on automation.
Key Implications
Businesses were generally optimistic, with transitory complications as a result of Hurricane Harvey noted as being substantial roadblocks during the quarter for those located along the Gulf Coast. Importantly, the manufacturing and construction sectors appear to be gaining momentum alongside the consumer, with investment likely to follow. This will mark the end of a period of deferred investment related to the caution that has prevailed following the election.
The upbeat tone of this Beige Book indicates that economic growth has gained momentum halfway through the third quarter. Although Hurricane Harvey is expected to shave 0.1-0.4 ppts. off growth in Q3, a rebound in Q4 is expected to leave the second half of the year largely unchanged on balance. Household consumption will be central to the strength GDP with income growth crucial for solidifying the continued important role of the consumer.
While so far producers are seeing their margins eroded, the increase in input prices reported should in the near future lead to higher inflation, as they begin to pass on past input price increases. Additionally, wage pressures were reported to have begun to mount in a few Districts, a trend that will likely proliferate in the coming months and will also support the inflation outlook. Next week’s CPI report will shed more light on the extent to which increases in producer input prices translated through to inflation. This will be of key importance to the Fed that will need to see improvement on this front in order to proceed with a hike in December as we expect.
