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Fed Fifth District economy shrinks slightly

The economy in the Federal Reserve’s Fifth District (a multistate region including Virginia, North Carolina, South Carolina, West Virginia and Maryland) has contracted slightly since March, according to the latest edition of the Federal Reserve’s Beige Book, released Wednesday.

Published eight times per year, the Beige Book is based on anecdotal information about economic conditions gathered from the 12 Federal Reserve Banks. It is compiled from reports by bank and branch directors, as well as information gathered from business contacts, economists, market experts and other sources.

Here’s what the April 19 Beige Book edition revealed about the direction the economy is taking:

Manufacturing activity softened as manufacturers had fewer new orders, and customers began pushing back on price increases as supply chain pressures eased. Employers continued to struggle to find skilled workers.

Travel and tourism spending increased moderately in the region. The sector saw strong revenue growth, with hotels reporting increases in the number of rooms sold and higher room rates compared with last year. In February, Virginia hotel revenues were 14.9% higher than those recorded in February 2019.

Ports and trucking companies in the Fifth District reported declining freight volumes, especially in imports of retail goods and household items. Exports of loaded containers were stronger, though, particularly in auto and machine parts. Empty containers remained at ports slightly longer.

Because shipping carriers had excess availability, their spot rates fell to pre-pandemic levels or below, significantly under contract rates. Airfreight rates stabilized as airlines pulled back on freight capacity, according to the Fed.

Trucking companies saw a moderate decline in freight volumes and received some customer pushback on continued rate increases. Firms continued to add drivers but scaled back recruiting because of the lowered freight volumes. The supply of new tractors and trailers improved.

The Fifth District’s employment increased slightly compared with its March report, although respondents reported a continued lack of qualified workers. Wages increased modestly, partly because Virginia, Maryland and Washington, D.C., increased minimum wages.

Prices in the region continued to grow at a strong rate, the Fed reported. Manufacturers reported average price increases of about 5.5%, down from the 2022 peak, and service sector firms reported prices increases of about 6.5%, a near-peak rate.

Retail activity remained strong, although firms reported slightly lower sales and demand. Some retailers said they expected business to pick up soon, as their busy seasons started in April.

The typical spring housing market did not appear. Sales and pending sales in the Fifth District residential real estate market declined, and sales prices remained flat, although respondents began seeing new contracts at less than list price. Housing inventory has decreased year-over-year, and new listings have dramatically decreased. Although construction costs were down, builders did not buy new lots because of economic uncertainty.

Commercial real estate activity declined overall last month, particularly in the office market. Retail and industrial/flex space leasing, however, remained strong, and the industrial sector had higher rental rates. Sales slowed due to rising interest rates, and some banks stopped lending for new commercial construction projects or tightened underwriting standards.

Demand for all types of loans slowed modestly, but the commercial loan portfolio was the weakest. The region saw mixed demand from consumers, but demand for home equity and used auto loans increased some.

Deposit levels declined slightly, although some banks had an inflow of deposits following Silicon Valley Bank’s collapse. Financial institutions expected loan and deposit levels to decline moderately for the rest of the year, according to the Fed.

Innovation, capital key to rural growth, Barkin and Warner say

There’s hope for economic growth in rural areas despite their challenges, Federal Reserve Bank of Richmond President and CEO Tom Barkin and U.S. Sen. Mark Warner said Wednesday during the Fed’s 2023 Investing in Rural America conference in Roanoke.

Rural areas could overcome economic development challenges, particularly housing shortages and lack of broadband access, with innovation, Barkin said, while Warner focused on access to capital as a solution.

“Simply put, the math just isn’t working to put new residents into housing that’s affordable for them. We don’t have enough supply, and building is getting ever more expensive with construction, interest and labor costs up,” Barkin said.

Small towns have additional challenges with housing because existing housing is often older construction, rough terrain makes it difficult to build, and absentee landlords can slow or prevent construction — all of which can lead developers to build elsewhere.

But localities can work to develop buildable sites for home developers or redevelop vacant commercial or municipal spaces, Barkin said. A Carroll County redevelopment provides an example: The county donated a high school, and Virginia Housing Development Authority helped identify a developer — Landmark Asset Services Inc. — and offered permanent financing at a below-market rate. Landmark redeveloped the high school into 51 affordable housing units.

On the federal level, there’s broad bipartisan support for some housing initiatives, Warner said.

One newer initiative that could help, Warner said, is the Neighborhood Homes Investment Act. Introduced by Sens. Rob Portman, R-Ohio, and Ben Cardin, D-Maryland, the act would create a federal tax credit to cover the cost between building or renovating a home in distressed neighborhoods and the price at which the homes could be sold.

“If you look at rural communities … virtually all over Virginia,” Warner said, “it is, not only the need for additional housing stock, but we’ve got a lot of old housing stock … that just isn’t fit to live in. So is there a way rather than starting from scratch entirely, but to think about putting a tax rate in place that will allow that reconstruction back into open market rate but also in a way that makes it happen?”

High-speed, reliable broadband is a necessity for any rural growth, Barkin and Warner said, an issue Barkin also touched on in 2019. Under former Gov. Ralph Northam, Virginia allocated more than $700 million of its almost $4.3 billion in American Rescue Plan Act funds toward broadband expansion. Nationally, the Infrastructure Investment and Jobs Act provides $65 billion to expand broadband access and subsidize the cost for low-income households.

“The bottom line on this issue is if we don’t get at least 97 to 98% broadband connectivity within the next three to four years in all of our states, at both high speed and affordability, then it’s going to be all on us in a failure of execution, because it’s not a failure of bringing capital to the table,” Warner said.

Another side of economic development is workforce cultivation, which small towns need to focus on to draw employers, Barkin said. When deciding where to locate big projects, companies seem to have shifted their primary focus from state incentives to talent.

One way small towns can help develop the local workforce and encourage entrepreneurs is by incentivizing workers to relocate to and work in their localities, Barkin said. West Virginia is testing a direct incentive: The Ascend West Virginia program pays select people to move to the state, providing $12,000 over the first two years, free access to a coworking space and free outdoor recreation and gear for a year.

But small towns can also incentivize local workers by creating access to affordable child care and transportation, he said, like the United Way of Southwest Virginia has through its child care initiative.

Wilson, North Carolina, implemented a successful transportation initiative, working with Via Transportation Inc. to replace its traditional bus system with an on-demand microtransit service that takes riders from curb-to-curb quickly for a low price. About half of those rides are to or from work, Barkin said.

Barkin lauded the Danville-area Great Opportunities in Technology and Engineering Careers (GO TEC) program for its work building a talent pipeline for Virginia target sectors, like health care and robotics. The program educates students in middle school about career pathways and relevant equipment. When they reach high school, students can complete industry certification programs.

Another key piece of rural revitalization is providing capital for entrepreneurs, Warner said, adding that such funding disproportionately goes to urban areas. In fiscal year 2021, Congress gave the Treasury Department $12 billion for Community Development Financial Institutions (CDFIs), of which Virginia has 16, he said, and Minority Depository Institutions. Legislation could help CDFIs by offering tax credits for longer-term capital deposits, provide CDFIs with funding for back office help and create a secondary market for CDFIs to sell debt, he said.

“The nature of many of these loans are bespoke to start with, and how can we then take this effort of bespoke-based loans, package them together and bring them to a secondary market?” Warner said. A secondary market or intermediary could package, or securitize, CDFI assets for investors. CDFIs would be able to gain a loan, sell it off and use the capital it receives to continue making loans without adding to their debt, a Local Initiatives Support Corp. paper explains.

Rural areas also need to develop pitches for companies and workers to locate and stay, Barkin said, citing Southwest Virginia, which has promoted its Crooked Road heritage music trail, the historic Barter Theatre in Abingdon, the Spearhead Trails for outdoor adventure and wineries, breweries and shopping for post-adventure activities.

“The good news is that remote work puts a lot more small towns in the competitive set, and that small towns offer a sense of place and community that many of today’s workers want, so long as they can also get the housing, broadband and amenities that they need,” Barkin said.

Barkin: Raising interest rates is correct course

As inflation remains high and the fallout from recent bank failures seems contained, the Federal Reserve Bank has good reason to continue raising interest rates, Federal Reserve Bank of Richmond President and CEO Tom Barkin said Thursday in a speech to the Virginia Council of CEOs at the University of Richmond.

“It is worth remembering that not every bank failure becomes Lehman Brothers,” Barkin said. “We’re all understandably scarred by the memory of 2008, but banks have failed throughout history, many without creating a broader crisis.”

On March 22, the Fed raises interest rates by a quarter-point, or 25 basis points, pushing rates to a range of 4.75% to 5%.

“If you back off on inflation too soon, inflation comes back even stronger, which requires us [the Fed] to do even more and cause even more damage,” said Barkin, who is currently an alternate member on the Fed’s powerful policy-setting Federal Open Market Committee. “With inflation high, broad-based and persistent, I just didn’t want to take that risk.”

While the broader implications from the failures of Silicon Valley Bank and Signature Bank and resulting actions taken by the Federal Deposit Insurance Corp., the Federal Reserve and Department of Treasury “aren’t yet clear,” Barkin said, banks, including in his region, the Fed’s Fifth District — a multistate region including Virginia, North Carolina, South Carolina, West Virginia and Maryland— seem to be resilient, with relatively stable deposit flows and adequate liquidity.

Meanwhile, the Fed’s interest rate increases don’t seem to be having much of an effect on inflation yet, with the headline consumer price index at 6% in February.

“Monetary policy is said famously to work with long and variable lags, but our 475 basis points of rate hikes over the past year have not yet compellingly moved inflation back to our 2% target,” Barkin explained.

Although inflation could drop quickly if banks tighten access to credit and the effects of increasing interest rates appear, Barkin said he expects it will take time for inflation to cool.

Economic disruptions from the COVID-19 pandemic continue, he said, with low vehicle and housing inventories, continuing order backlogs and a tight labor market. Consumers have unprecedented levels of wealth: “There was stimulus and suppressed spending that together still haven’t been put in the economy — well over a trillion dollars,” Barkin said.

Barkin also pointed to increasing prices and wages, as sectors like health care, utilities and food seek to restore margins to pre-pandemic levels and workers who saw a decline in their real wages seek higher wages to catch up.

Richmond Fed President and CEO Tom Barkin speaks in the University of Richmond's Jepson Alumni Center.
Richmond Fed President and CEO Tom Barkin speaks in the University of Richmond’s Jepson Alumni Center. Photo by Katherine Schulte/Virginia Business

High pricing is the third inflationary pressure that Barkin is watching.

“Supply chain challenges have just worn down purchasing departments,” he said. “They now seem more willing to accept increases, at a time when volatility has made supplier cost structures more opaque and availability more important.”

The Fed will have to be nimble, Barkin said, since the effects of the banking crisis and of high inflation could have wide-ranging results. “And if I’m wrong about the pricing dynamics at play, or about credit conditions, then we can respond appropriately,” he added.

On Thursday, Federal Reserve Bank of Boston President Susan Collins also backed the Fed’s decision to increase rates by a quarter-point in a speech during the National Association for Business Economics (NABE) Economic Policy Conference in Washington, D.C., according to Yahoo!Finance.

What does the future hold? What has happened in the economy in the last two or three years is almost like what happens when the country goes through a war, Barkin said, with lots of spending, monetary support, people moving in and out of jobs and inflation as a result. He’s hopeful the U.S. economy will get through the “post-war” period and calm.

“My hope is that on the backside of this is something that looks more normal,” he said, “looks more like the early ’20s, it looks like the late ’40s and early ’50s, where supply and demand have the opportunity to get back into balance through whatever combination of demand side moves, like the ones we’re making with rates, or supply side moves, like the ones I referenced earlier.”

Mortgage rates above 7% shock volatile housing market

Denise Ramey

Charlottesville Realtor Denise Ramey has a client who put in multiple bids for houses over the summer, when the market was booming, but they were all turned down. Now, with mortgage rates topping 7% for the first time in more than 20 years, he’s not sure if he will buy a house at all — or whether he might look outside Virginia to markets where he can get more bang for his buck.

The rate on a 30-year fixed mortgage, which many homebuyers use to take out loans, averaged 7.08% for the week of Oct. 24, sending ripples through an already volatile housing market. It was up from 6.94% the previous week and more than double the average of 3.14% a year ago, according to Freddie Mac’s primary mortgage market survey.

The client, who was shopping for houses listed at above $800,000, represents the typical buyer Ramey works with: people qualified for a mortgage and able to put 15% to 20% down.

“That was a real eye opener for me,” said Ramey, owner of Denise Ramey Real Estate LLC/Long & Foster and the president of Virginia Realtors. “I expected he would be reducing the price range, but I did not anticipate the level of frustration and negativity he expressed today.”

‘Something psychological’

Lisa Sturtevant

Mortgage rates have been rising swiftly for the past few months, said Lisa Sturtevant, chief economist for Bright MLS, but there’s something psychological that kicked in with rates rising above 7%, she notes.

“It’s higher than anyone in this demographic cohort can remember,” she said.

First-time homebuyers — who tend to be younger with less income — will be impacted the most, she said, by a double whammy of higher prices and higher interest rates. Repeat home buyers, who have benefitted from record growth in housing equity, will be less impacted, Sturtevant adds.

The rise above 7% comes as a shock.

“A few months ago, most places were not forecasting 7%,” said Ryan Price, chief economist for Virginia Realtors.

Big unknowns include whether the Federal Reserve will raise rates again as expected during its Nov. 1-2 meeting and how much inflation grew during October.

Earlier this year, inflation hit a 40-year high, and although the Federal Reserve has raised interest rates to battle the rise, prices have continued to spike.

“In general, if we see inflation come down, the [Federal Reserve] will ease up and settle in at a rate that could hit as high as 8%,” Sturtevant said, adding that it’s likely that rates could settle in between 7% and 7.5%. Double-digit rates are unlikely in her opinion.

Price had a similar view.

“We’re in a pretty volatile stretch of market right now so it’s pretty hard to predict,” he said. “Until we see sustained evidence that inflation is receding, it’s likely that upward pressure on mortgage rates will continue.”

Changes in inventory

In September, 10,172 houses were sold in Virginia, about 3,000 fewer than a year ago, or a 23.1% decrease, according to Virginia

Ryan Price

Realtors. At the end of the month, there were 19,793 active listings, a 2.9% supply drop from a year ago. The median sales price statewide was $365,000, up 4.3% from a year ago.

But the inventory situation is improving, Sturtevant noted, because there are fewer potential buyers making offers. She doesn’t see a “balanced market” happening until next year.

“There may be fewer buyers, so sellers are competing for fewer buyers, but at end of day, sellers will still be in the driver’s seat next year,” she says.

With buyers pushing pause on home searches as rate increases leave them with less purchasing power, “some sellers are [in turn] likely spooked by this cooling demand and more are reluctant to list their property right now,” Price said.

In Virginia, price growth will slow in the Northern Virginia suburbs and Richmond, but regions such as Hampton Roads — coastal markets — and places where people have second homes, are at the biggest risk for declines. “Zoom town markets” — scenic places with high-speed internet access that attracted remote workers, such as the Shenandoah Valley — have had to reset to local incomes instead of appealing to relocating buyers who were willing to pay higher prices. Metro areas are more stable.

Sales activity is slowing down in most places in Virginia, which is not a new trend. It started about a year ago, Price noted, when the market started slowing, but the slowdowns have accelerated in recent months due to increased interest rates.

Where Ramey is, in the Charlottesville area, available housing inventory remains lower. When a property does come on the market in an area people find desirable, such as Western Albemarle County, there will be multiple offers.

Normally, at this time of year, she would have 10 to 15 houses under contract to close in December. But not this year. “We’ve had another great year, but what I’m seeing is, it wasn’t even a slowdown, it was a ‘hit the brakes’,” she said.

“It will be interesting to see what plays out. It really is that crazy of a market right now, where it’s very transitional.”