Fed's Beige Book Confirms US Economy Is Slowing

Ever since April, the otherwise drab and colorless Fed Beige Book, was notable for one specific trend: a rising frequency of the word "tariff" with every subsequent report, confirming that in addition to the usual concerns businesses voiced to the regional Fed such as labor and prices, one of the growing worries amid local companies was the impact of trade war on future business. And, as we noted last month, with the Trump-Xi summit fast approaching, the Beige Book confirmed that with no less than 51 mentions of the word "tariff", most companies were on edge over future trade prospects.

  • March Beige Book instances of word "tariff": 0
  • April Beige Book instances of word "tariff": 36
  • May Beige Book instances of word "tariff": 22
  • July Beige Book instances of word "tariff": 31
  • September Beige Book instances of word "tariff": 41
  • October Beige Book instances of word "tariff": 51

Today, the December Beige Book was released, and in a notable development, we saw the first decline in mentions of "tariffs" since May, with the word used "only" 39 times, a steep drop from October's 51.

And while superficially this may be taken as a good sign, another, perhaps more ominous trend has emerged.

But first, a quick glimpse at what else today's Beige Book revealed: a casual glance of the summary page revealed few surprises. Indeed, according to the Federeal Reserve, most regions reported growth at an overall modest to moderate pace, and while the overall near-term growth outlook remained positive, some contacts cited tariffs, rising interest rates, and labor market constraints as reasons for waning optimism. Employment growth slowed, partly because of labor shortages from increasingly tight labor markets. A majority of Districts noted capacity constraints due to difficulty in attracting and retaining workers.

In further good news for workers and wage growth,the Beige Book noted that "wage growth tended to the higher side of modest to moderate", even as employment gains ebbed "due in part to worker shortages" while most disticts had examples of boosts in nonwage benefits." Overall, this is a welcome development for American workers, if not so much for markets, which are on edge ahead of Friday's report on average hourly earnings, which - if this report is any indication - may print above the 3.1% Y/Y consensus and spark more concerns that the Fed will have no choice but to remain hawkish.

In a potentially troubling development for markets - and those keeping tabs on wage inflation - most Districts noted wage growth had increased, and prices rose at a modest pace overall. There were widespread reports of input price pressures, with some Districts noting tariffs had lifted prices. Still, while October cited "modest to moderate" price rises, in December this was downgraded to just "modest."

Making matters worse, the Fed noted that while price growth was modest, input costs rose faster than final goods prices, which is another way of saying "margin compression", and yet another confirmation that peak profits may have indeed arrived. Not surprisingly, businesses once again were quick to blame tariffs for margin compression, with the Beige citing spreading reports of "tariff induced cost increases", and that "tariffs remained a concern for manufacturers", while "optimism waned in some disticts on tariffs, rates and labor."

But the most concerning news was the all too clear notice by the Fed that the economy itself may have peaked, with the report explicitly pointing out that Dallas and Philadelphia reported "slower growth."

Meanwhile, as noted above, while the use of the word "tariff" may have declined for the first time in half a year, another word took its place: as shown in the chart below, the word "slow" and its variants appeared on 43 different occasions, a notable increase from 37 in October and 25 in September, which is the range it had been for most of 2018.

This rather clear hint from the Fed, or at least the various regional Fed constituent firms, that growth is moderating is not surprising, given that the economy is growing above trend and a slower expansion is embedded in the Fed's forecasts. But, as Bloomberg's Ye Xie notes, the report points to a clear late cycle market in 2019, one marked by lower risk-adjusted returns and much higher volatility (as BofA warned in its year-ahead preview yesterday).

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Finally, there were the usual memorable anecdotes from the various regional Feds, of which the Chicago district was perhaps most remarkable, as "a number of contacts said that they had been "ghosted," a situation in which a worker stops coming to work without notice and then is impossible to contact." We observed the rise of this phenomenon back in July in "'Ghosting' On The Rise As Workers Blow Off Interviews"

Here are the other anecdotes (source: Bloomberg):

  • Boston: Massachusetts restaurants continued to note acute labor shortages and higher labor costs, citing the Commonwealth’s recently implemented Employer Medical Assistance Contribution (EMAC) and scheduled hikes in the minimum wage

  • New York: A couple contacts lost existing and prospective skilled workers due to immigration restrictions, including H-1B visas not being renewed.

  • Philadelphia: One staffing firm noted that its roster of qualified job candidates is essentially tapped out -- it has become very difficult to find qualified applicants to replenish its candidate pool.

  • Cleveland: Some concern that seasonal patterns may be unusual this year as firms try to import goods before additional tariffs on Chinese goods take effect on January 1

  • Richmond: A cabinet manufacturer reported an uptick in business in recent weeks, as customers rushed orders in anticipation of higher tariffs in the new year.

  • Atlanta: Several contacts pointed out that overall compensation costs were expected to increase at a slightly faster pace in 2019

  • Chicago: A number of contacts said that they had been "ghosted," a situation in which a worker stops coming to work without notice and then is impossible to contact.

  • St. Louis: Local contacts note that barge activity has increased due to the large number of storage barges for soybeans affected by recent tariffs.

  • Minneapolis: A tight labor market for high-tech skills in Minneapolis-St. Paul has led to double-digit wage increases for some information technology and other STEM positions over the past 12 months.

  • Kansas City: International geopolitical discussions surrounding waning OPEC production and U.S. sanctions on Saudi Arabia may affect District energy prices and production expectations moving forward.

  • Dallas: A manufacturing equipment supplier reported frequently raising wages to prevent its employees from being poached by other firms, and one contact noted high employee turnover despite paying their groundskeepers $20 an hour.

  • San Francisco: Drier-than-usual conditions in parts of California lowered yields for select crops, like nuts and tomatoes, but contacts noted that inventories were at an adequate level to meet demand.