U.S. Regional Outlook: Seeking Stability Amid Recession

View the Moody's Economy.com Regional Forecast.

• Recession now engulfs virtually all U.S. states and metropolitan areas.

• Confidence is beginning to stabilize; surprisingly, the Northeast leads the way.

• Manufacturing in the Midwest and Southeast—excluding automakers—will get a lift as new orders stabilize.

• House prices have dropped enough in the weakest markets to entice investors and first-time buyers.

Virtually every area of the economy is in recession. Alaska is the only state still not in recession, and even there, employment is no longer rising, and state spending is being maintained only through its ample reserves. The District of Columbia is also avoiding recession because of the expanding federal government, although even Washington's largesse has not been enough to spare the surrounding metropolitan region.

Never since reliable regional employment data became available in the early 1970s has a U.S. recession been this broad. The only period that came close was 1974-1975, when the energy crisis had the same broad impact that the combination of housing, finance and international trade is having today. Of the country's 392 metropolitan areas, only a handful of small metro areas in Alaska, North Dakota and Texas have escaped recession.

The first quarter of 2009 was particularly weak. Employment fell from the fourth quarter in all 50 states and in nearly all metropolitan areas. The Northeast posted the smallest loss, amounting to an annualized decline of more than 4%. The Midwest performed the worst, with a decline exceeding 7%.

The deepest labor market downturns are occurring in regions most exposed to the housing downturn or to durable goods manufacturing. Thus, jobless rates have soared in California, Nevada and Florida , where housing and household finances have been troubled for some time. The industrial Midwest is feeling the loss of demand for autos, construction equipment, household durable goods, and industrial equipment, compounded by weak export markets. These trends have now extended to the Southeast. High exposure to export markets keeps the Pacific Northwest highly cyclical as well.

More recently, weakness has extended to the heretofore stable Plains and energy-producing Mountain states. But income growth is slowing, as commodity prices are well off their historic highs of last year. The impact is beginning to be felt in slower growth in retail sales and state tax revenue. If any region has an opportunity to emerge from recession early and with little damage to households or state and local governments, it is this area. Commodity prices remain above historical trends, and notwithstanding ample current supplies, prices for commodities such as crude oil edge up with any optimistic economic indicator.

Positive regional trends are emerging in a few leading indicators. Consumer confidence could still be knocked back to the floor by any number of surprises in coming months, but it has rebounded modestly since February. According to the Conference Board's regional indices, the rebound is sharpest in the energy-producing regions, following recent gains in commodity prices. Interestingly, the turnaround has been a bit stronger in the Mid-Atlantic. A marked improvement in sentiment stems from a feeling that the financial services industry has seen the worst of its troubles and a path out of the woods is emerging in the distance. The industrial Midwest has gained the least traction, along with New England.

Some glimmers of light are evident among manufacturers as well. A diffusion index reading of less than zero still indicates contraction, but the zero line has come into sight in recent months in the regional Fed surveys. Indices for new orders are being closely watched for signs of a turnaround. Richmond, Kansas City and New York are closest to zero, indicating an approach to balance between negative and positive characterizations of new orders by survey respondents. Combined with a sharp downturn in inventories, these indices are early indicators of manufacturing stability.

Midwest manufacturing limping

The industrial Midwest will limp through this summer's extended shutdowns of auto production plants. General Motors will close plants a minimum of 10 weeks in Fort Worth, Detroit, Flint and Fort Wayne. Shorter closures will take place elsewhere. All Chrysler production plants will be closed during the firm's bankruptcy proceedings, with permanent closings expected at plants in Kenosha, Akron and St. Louis, and three in the Detroit metro area. Direct income effects will be blunted in the near term by union and state unemployment benefits, but the accompanying closure of a myriad of auto parts makers will hit the Midwest economy more directly. Expect Michigan's unemployment rate to peak at nearly 15%, the highest in the nation, some time next year.

Northeast's woes to linger

The Northeast labor market remains somewhat resilient to the financial crisis. Jobless rates are up, but by no more than average, and new claims for unemployment benefits are at or below the U.S. rate. But the effects from weaker income trends will be long-lasting. Income fell in Connecticut in last year's fourth quarter by an annualized 3%; New York's decline was 1.5%. These compare with a decline elsewhere in the U.S. of 0.7%. Continued job cuts, smaller bonuses, and slower investment income will hobble the region through 2010, adding downward pressure on regional consumer spending and real estate markets.

Stability emerging in Southeast, Southwest

Residential real estate markets in these regions are showing the first expected indications of stability. Home sales in California are now more than double their low point in the fourth quarter of 2007. Sales were slower to turn in Florida but are now 25% above their low point registered in the first quarter of 2008. Homebuilding will be the next housing indicator to improve, although California and Florida will not lead the way, as rising foreclosures will keep ample supply on the market. Home prices may not stabilize for another year in Florida and the Southwest. Nevertheless, prices have fallen enough in the nation's weakest housing markets—aided by lower interest rates and tax incentives—to interest both investors and first-time homebuyers.

The multiplier effects are small. New construction remains moribund, and lending no longer is structured to allow borrowers to also buy furniture or make repairs, but it does raise such demand modestly. A wave of mortgage refinancing also will add to spending, but this impact may be greater in markets that hadn't suffered the steepest house price declines. Despite government incentives to lenders to encourage refinancing, households in the Southwest and Florida may have difficulty refinancing or restructuring loans if they owe significantly more than the current value of their property. Refinancing may provide a better boost to household finances in the Plains states, the mid-South, and parts of the Northeast.

The outlook is grim for 2009. Employment will fall in all 50 states this year, and no area of the country will escape recession. Next year will look better. Much of the South and West will return to moderate growth. Tech-producing areas will help lead the way because of federal stimulus measures, renewed export demand, and an aging domestic technology base. Centers of international trade and regional distribution/logistics should also stabilize as consumer demand and industrial production rebound. Energy-producing regions should also gain as rebounding confidence in the U.S. and global economies lifts energy demand somewhat.

This year's rebalancing and refinancing of housing markets will mean greater demand next year for furniture, paint, appliances, and construction and repair services, and will ultimately increase property and sales tax revenue for local government. Also, the rapid drawdown of inventories will spur manufacturers in the Midwest and Southeast to get production lines going again. Even the auto industry—what remains of it following the extended summer shutdowns and bankruptcy proceedings—will need to replenish inventories with fresh models later this year as some demand begins to build.

Risks all to the downside

Risks in all regions remain largely weighted to the downside. Risks are greatest in the Northeast, where the full impact of the financial crisis has yet to ripple through the region. If real estate prices fall further than expected, employment cutbacks extend further into 2010, or federal efforts fail to stabilize lending, the Northeast could struggle for at least another year.

Risks to the downside are considerable in the industrial Midwest as well. These risks will be clarified over the next two months as the prospects for restructuring or bankruptcy become clearer for GM. Risks are even beginning to emerge for transplant automakers that are slowing their pace of new U.S. investment in the face of deepening global losses. Such trends are evident in other manufacturing industries as well. Thyssen-Krupp, for example, has slowed the pace of investment at its new mega steel mill going up in Mobile AL.

Consumer and business confidence will be a key factor in whether regional labor markets soon stabilize. The summer travel season will be telling and may help define the pace of turnaround in vacation destinations such as Southern California, Central Florida and coastal areas. Improving consumer confidence adds some upside potential, although it will be buffeted by rising fuel prices. Business confidence will be key to improving regional labor markets.