Hopeful Economic Signs Complicate Fed's Task

(Oct. 20) -- There's an uptick in business travel and tourism, consumers are more willing to buy cars, and retail forecasts for the holidays are upbeat. Those new signs of growth in the laggard U.S. economy are welcome, but they could complicate policymakers' efforts to spark a bolder expansion.

The Federal Reserve's regular gathering of anecdotal information from the business and banking contacts of the regional Fed banks found that "on balance, national economic activity continued to rise, albeit at a modest pace."

That may not sound terribly bullish.

But this latest compilation of information collected from September through early October -- known as the Beige Book for the color of its cover -- provides a stark contrast with the last one from the late summer, when the 12 regional Fed banks reported "widespread signs of a deceleration."


And coming just two weeks before Fed officials meet in Washington to decide whether to employ a crisis-era tool to flood hundreds of billions of dollars into the economy, today's report is sure to inflame debate.

Though the Beige Book lacks concrete statistics, it is one of the principal ways Fed policymakers get a feel for working, spending and business trends around the country when they're trying to decide what to do with interest rates and how to manage the economy.

Today's edition adds several positive pieces to a puzzle that for several months has depicted an economy growing steadily if slowly but held back by a labor market still weakened by the trauma of losing more than 8 million jobs in the recession. It also brings evidence of potential inflation.

Selling More Semiconductors and Cars

Manufacturing activity continued to expand, and in several parts of the country production and new orders were on the rise "across a wide range of industries," the Fed said.

That included semiconductors and other high-tech equipment produced in the San Francisco Fed's region, auto production in the Cleveland and Chicago districts, increased sales and shipments of steel and other metals in several areas and solid demand for the likes of food processors in the Philadelphia and Dallas districts.

"Manufacturers' assessments of future factory activity were optimistic in the New York, Philadelphia, Chicago, and Kansas City Districts, where contacts expect business conditions to remain positive or to improve in coming months," the Fed said.

Among the service industries, demand for information technology was solid, as was health care consulting, while appraisal and title companies reported continued strength and architecture firms said activity was picking up.

The Fed's contacts in the Kansas City region reported stronger-than-expected retail sales, which seemed to be the story for all but the Richmond, Va., and Atlanta districts. In much of the country, sales of new vehicles held steady or rose, and "sales of used vehicles were strong as well," with rising prices that reflected "solid demand and lean inventories."

"Retailers said consumers are slowly regaining confidence, but remain price-conscious and were largely limiting purchases to necessities and nondiscretionary items," the Fed said. "There were reports, however, of a pickup in sales of moderately priced household goods in the Philadelphia, Dallas, and San Francisco Districts, and gains in apparel sales were reported in the Atlanta and Chicago Districts."

Several districts expect improved sales toward the end of the year, and "in particular, some contacts in New York planned to add more holiday staff than last year."

Recovery in the Gulf?

Hotel occupancy rates were improving as tourism and business travel increased in most districts. And even in some areas afflicted by the Gulf of Mexico oil spill, losses were offset by increased travel activity in northeast Florida, Georgia and Tennessee. Energy firms in the Dallas region said some of the losses from the moratorium on new drilling in the gulf had been compensated by a pickup in overseas demand for their work and an increase in land-based drilling.

Still, demand for construction-related products remained weak, a symptom of the economy's biggest Achilles' heel, the real estate market. Home sales were sluggish or declined in most regions, with only scattered reports of improving sales; construction activity remained low; and the commercial real estate sector was still subdued.

The report also didn't offer much reassurance on the jobs front.

"Hiring remained limited, with many firms reluctant to add to permanent payrolls given economic softness," the Fed said. Though demand for temp workers picked up in some places, "the Atlanta report noted a preference for increasing staff hours and using temporary help rather than hiring additional full-time staff."

And overall, "wage pressures remained minimal."

But some other important costs are rising, and that's what might prompt the Fed to rethink potential action.

Inflation vs. Deflation

The prices of corn and other food commodities were on the rise, shipping costs increased in several regions, petrochemical costs rose in others and retailers from some districts said their wholesale prices were higher.

A pivotal phenomenon since the recovery began has been companies' reluctance to pass rising input costs on to their customers. But that, too, seems to be changing.

"A few manufacturers in the Boston District said recent price increases on some of their products had been successful," while manufacturers in the Atlanta region "noted rising costs of materials and employee benefits would likely be passed on to customers in the near-term, and several manufacturers in the Cleveland District announced plans to raise product prices in an attempt to recover rising costs," the Fed said.

These nascent signs of inflation will ignite the most controversy at the Fed, where fears of falling prices, or deflation, have been cited as a key reason for any new action.

On Monday, Atlanta Fed President Dennis Lockhart, one of the Fed officials who says he's "leaning in favor of additional monetary stimulus," called such a move "an insurance policy" against the risk of deflation. But he also acknowledged it risks creating an "unstable inflation situation" that could be a lot harder to fix down the line.

Increased inflation could also cancel out any relief the Fed hopes to offer to workers and the unemployed.

The Labor Department today reported that even the mild increase in prices consumers experienced in September was more than the increase workers saw in their wages -- meaning Americans' real earnings, adjusted for inflation, fell by 0.1 percent for the month.