Fed Report Spotlights Main Street SMB Labor and Lending Pressures

Slowing rate hikes cheer investors, but on Main Street the damage has already been done.

Stocks surged about 3% by Wednesday’s close, on the heels of signals from Fed Chair Jerome Powell that — after four consecutive 0.75% rate increases — a 0.5% rate hike would be in the works next month.

But that same day the Fed also released its latest edition of its Beige Book.  The document collects and summarizes, in qualitative fashion, the sentiments of businesses across the 12 Federal Reserve districts. And that sentiment is, decidedly, mixed — certainly among the businesses that power the U.S. economy.

The report found that, overall, economic activity was about “flat or up slightly” depending on where one looks, while in the previous report, just last month, there had been a moderate pace of growth in place. Drill down, and five districts reported slight/modest economic gains; the rest, in other words, a majority, were flat to down.

“Business contacts have become increasingly pessimistic about the near-term outlook,” the Fed reported. Rising interest rates are curbing spending from end customers, and consumers want to see discounts when they do buy.

Pressures Are Mounting

At the same time, bank lending has seen modest declines, with weak demand and tightening credit standards, per the report. We note that the weakened demand may be  a result of worries over growth prospects. Higher interest rates (and tighter credit) also make debt more expensive, of course. The read across here may be that working capital and other financing becomes a tougher obligation to carry (should it be accessible).

And, as for operating costs, the Beige Book noted that though most districts saw modest growth, two districts (including New York) reported flat headcounts and labor demand weakened.

“Scattered layoffs were reported in the technology, finance, and real estate sectors. However, some contacts expressed a reluctance to shed workers in light of hiring difficulties, even though their labor needs were diminishing.”

That last sentence may be taken to mean that at least some Main Street businesses are keeping staff in place even though they are facing business conditions that don’t merit keeping that staff on board. When top lines weaken, but input costs rise or at best remain the same, margins take the hit. Rising producer prices are not helping matters, as we reported earlier this month.

In the latest iteration of our Main Street survey, we found that wage volatility and labor shortages continue to challenge Main Street firms’  ability to grow profitability. At mid-pandemic lows, wages and employment had fallen by 43% and 48% annualized, respectively.

Now, both have rebounded strongly, but it is becoming clear that companies are in a Catch 22: If they shed workers, they lose talent, and the negative ripple effect is that laid off workers will be less able to put money back into the economy, which hurts top line momentum. If they don’t shed workers, they have to find ways to keep paying them, or absorbing the costs, right as traditional means of financing remain somewhat scarcer.