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Three Trends Influencing the Region's Growth

Trends in energy prices, steelmaking, and auto production could determine the course for the 2016 regional economy.

As we enter 2016, national economic growth continues at a moderate pace, but this growth hasn’t prevented some nervousness about the outlook for the US economy. Notably, the stock market moved sharply lower in the third quarter of 2015, though it has subsequently recovered much of those losses. This decline in stocks, according to market commentators, was in large part due to concerns about geopolitical events and the softness in emerging-market economies. And these issues have continued to contribute to a volatile stock market in the early part of 2016.

Focusing on our region, which comprises Ohio, western Pennsylvania, the northern panhandle of West Virginia, and eastern Kentucky, the data show continued growth. However, we have noticed more nervousness about the outlook for growth among some of our regional contacts.

To supplement the District’s economic data, we regularly collect qualitative assessments of the District economy from a wide range of contacts. Over the past year, those assessments have suggested a gradual weakening of the District’s economic growth. At the start of 2015, our Beige Book summary of the region’s economy noted ongoing “moderate growth,” and most of our contacts had “a positive outlook for the new year.” By the November Beige Book, however, our District’s assessment of growth was lowered to “modest,” with factory output being “stable” on balance.

While the reports we’ve been receiving from Beige Book and other business contacts are best interpreted as mixed, fundamentals (like employment growth) for the broader District economy are good. So despite the weakening sentiment of District contacts’ reports and the cautious tone of the stock market, we continue to expect growth across the District in coming months.

Three important trends underlie our view of the District’s pace of economic growth.

  1. The fall in energy prices has caused a significant slowdown in oil and gas exploration in the Marcellus and Utica Shales, though natural gas production remains at historic highs.

    Oil prices slid dramatically in late 2014 when worldwide demand for oil failed to keep up with rising supplies driven by renewed growth in US production. Domestic production has rebounded gradually over the past few years as drillers have brought resources to market with the combined technologies of hydraulic fracturing and extended reach drilling, or ERD.

    Use of these technologies has been growing in the Fourth District, as well. Ohio and Pennsylvania experienced 25.7 percent and 12.8 percent rises, respectively, in oil and gas extraction employment between January 2013 and January 2015, mostly in the Marcellus and Utica Shale regions in western Pennsylvania and eastern Ohio. However, the number of active drilling rigs across the District began a rapid decline in February 2015 and has declined more than 50 percent during the entire year after peaking in mid-December of 2014. One evident point is that Fourth District drilling is sensitive to natural gas prices, and this sensitivity explains the slowdown in drilling activity in 2012. However, recent oil and natural gas price declines had an even larger impact on drilling activity this year. While low energy prices result in higher discretionary income for consumers and wider margins for energy-intensive industries, they also contribute to widespread layoffs by exploration and production companies.

    Of course, direct employment is only part of the story in affected regions: Suppliers, restaurants, other service providers, and royalty-payment recipients have all experienced the slowdown. Helpful for continued District activity is that natural gas production within the District includes other components such as ethane, which is a building block of the plastics industry. More positively, anecdotal reports suggest ongoing investment, albeit at a modest pace, in midstream natural gas projects as well as the potential for construction of one or more ethane crackers. These midstream and downstream investments could potentially support ongoing growth in the energy sector despite today’s low energy prices.

    Fourth District drilling is sensitive to natural gas prices.
  2. The rising value of the dollar and the weakness in oil and gas exploration have affected key District industries, including steelmaking. Steel producers are encountering difficulties even while domestic market users of District manufacturing products, namely construction and transportation equipment, are seeing growth.

    Critical suppliers to the oil and gas industry—steel producers and steel service centers—have been affected by the slowing in exploration, but the larger issue has been the weakening in developing markets and the strength of the dollar. Foreign steel producers, benefiting from a drop in the value of their home currencies but also experiencing weak demand in their own countries, have put significant downward pressure on international prices of steel.

    It’s an important headwind in the region because steelmaking still maintains a significant presence across the District. Every state in our District has at least twice the typical employment share of primary metals workers, with Ohio’s share sitting at 2.6 times larger than national figures.

    The decline in steel prices will likely impact the Fourth District's economic outlook.

    Steel production declined 11.5 percent nationally from the third quarter of 2014 to the third quarter of 2015, though it has slowly risen since October 2015. Although this decline is not as large as the decline during the Great Recession, when national production fell more than 50 percent, according to the Federal Reserve Board of Governors’ industrial production data, steel industry contacts are not optimistic about today’s environment or the near-term outlook. A lack of optimism will likely weigh on the District’s economic outlook, but other consumers of steel such as the auto industry continue to perform at an elevated level.

  3. Nationally and regionally, consumers are increasing purchases of durable goods, particularly automobiles, as their circumstances and balance sheets improve.

    While there are challenges to the District’s economy, national consumer spending is supporting continued growth in both the nation and the region. Regionally, this situation is most evident in one of the District’s key industries: automobile production.

    The recent surge in automobile sales has bolstered District production.

    In recent months, automobiles have been selling in the United States at a rate of more than 18 million per year. This is an extraordinary figure, and it means that District auto production has returned to more than 2 million cars per year. District auto plants over the last several years have produced about 17 percent of the nation’s cars and light trucks—and they still do despite the 2008 closure of Moraine Assembly, an SUV plant in Dayton, Ohio. That plant produced 212,000 Chevy Trailblazers and other SUVs in the 2007 model year. District auto contacts expect that the pace of growth in unit sales will level out in the near-term, but they remain optimistic in their outlook.

The Fourth District is experiencing some headwinds weighing on the regional outlook, but these are tempered by some favorable trends. Pulling disparate trends together shows a mixed economic outlook for the District, but one still consistent with continued growth, albeit at a moderate pace. Meeting the needs of domestic consumers represents almost 70 percent of US output, so with an improved labor market and with household balance sheets in better condition, most national forecasters are expecting steady growth in consumption. This powerful factor supports the national outlook, and it should similarly support District growth.

Read more

  • Read the latest Fourth District report in Beige Book.
  • Interested in the the region's 2015 employment progress? Read "Year in Review: Fourth District Labor Markets."
  • The Cleveland Fed’s Fourth Federal Reserve District is profiled in Metro Mix, our publication providing snapshots of economic conditions and prospects for the six MSAs featured here. For more information on their economies, including data and analyses, read Metro Mix.

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