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• What Businesses Are Saying: Few Signs of Major Shifts
• What Businesses Are Saying: Activity Up, but Expectations Mixed

Transcript

Tim Sablik: My guests today are Andy Bauer, Renee Haltom, and Matt Martin, all regional executives at the Richmond Fed. Andy, Renee, and Matt, welcome back to the show.

Andy Bauer: Hi, Tim. It's good to be back.

Renee Haltom: It's always good to be here.

Matt Martin: Happy to be here, Tim.

Sablik: A major part of your roles as regional executives is engaging with business and community leaders across the Richmond Fed's district to learn about local economic conditions. This economic sensing helps inform our bank president, Tom Barkin, as he participates in monetary policymaking on the FOMC. This information is particularly valuable at times when other types of economic data are noisy or maybe slow to reflect sudden changes in the economy.

In September, you all launched a new regular column on the Richmond Fed's website to share some of the insights that you're hearing. Today, we're going to dive into the latest update on that.

Since things can change fast, I'll note that we're recording this conversation on Oct. 22.

Let's start with the overall outlook for the economy. How optimistic or pessimistic are businesses feeling about the U.S. economy as a whole, and has their view changed from earlier in the year?

Bauer: On the whole, businesses are feeling a bit more optimistic now than earlier in the year. A lot has happened this year — for example, significant policy changes with respect to tariffs. That uncertainty continues. Currently, the federal government is in shutdown and trade issues have resurfaced. But what I hear from businesses is that they have largely found a way to manage through the changes and the uncertainty. However, for many businesses, it is still a tough business climate. I talked with a business earlier today that said while the economy doesn't feel great, it's not bad either.

Haltom: Yeah, I would say that cautious optimism feels like an appropriate phrase.

Sentiment has been a pretty wild ride on the part of businesses this year, with lots of concern right after tariffs rolled out in April to some relief when the economy didn't come to a screeching halt as some people expected. In fact, at some points in the last few months, I had businesses saying that the lack of a more negative outcome in the face of so much uncertainty was itself a positive sign. They were taking it as a sign of the economy's fundamental resilience.

In other cases, businesses could simply no longer delay certain decisions like restocking inventories or filling a role or making certain investments, which gave the economy a feeling that activity had picked up some. By the end of summer, a lot of firms were saying that the summer had ended stronger than it began.

Martin: I'd agree with all those comments. I would probably want to emphasize something Andy said. The uncertainty that has been around pretty much all year, it feels a little bit better now and a lot of firms will say, "Now we can see our way through."

Back in the spring, it was sort of throw the hands up, no idea how we're going to deal with this. Now they have developed plans. If they're tariff exposed, the tariffs aren't as bad as they thought they might have in the spring. They've figured out ways to mitigate the costs and otherwise find their way forward. Now, at the end of the year, they're looking into next year, making plans, and they're saying it'll be OK — not necessarily great, but it's better than expected.

Sablik: So, cautious optimism overall.

What are businesses saying about their own prospects? Are you hearing different stories in different sectors?

Bauer: I've been talking with a lot of businesses in the Greater Washington, D.C., region, and what they're saying is that business is off. It isn't declining sharply, but activity is more modest or flat, or in some cases it's down slightly. This is across sectors when I talked to restaurants, leisure, consumer goods, staffing, a lot of consumer-facing firms in particular.

Obviously, cuts to federal employment and federal spending are having an impact on the region's economy. The federal government shutdown and possible additional federal job cuts have added another layer of uncertainty, which is also affecting economic activity.

There are sectors that are doing very well. I talked with a couple of engineering firms. Their focus is infrastructure work. They have more work than they can handle, and they're hiring all the people they can find. And, anyone who's involved with data center work, they're having an exceptionally good year.

Haltom: For Virginia, I'll have to tack on to data centers. In Virginia, that's a huge sector. We have "Data Center Alley" going through northern Virginia, and that business is really spreading throughout other parts of Virginia. So in this state, if you manufacture or construct anything related to data centers — whether it's the structures themselves or switchgear or electrical components — you're really feeling demand as far as the eye can see. That's how businesses talk about it.

Another important sector in Virginia is, of course, the government contracting sector, which is really concentrated in northern Virginia. That is a sector that has been facing the repercussions of the federal cutbacks this year. That is undergoing a degree of decline. The thought is that it's going to bottom out at some point and then maybe even having some rebuilding into 2026, with the timing uncertain.

Martin: The Carolinas are a little bit of a different story. We're still seeing some pretty solid growth regionally. Firms that are mostly local or regional in nature are doing quite well, for the most part, unless they sell to lower- and moderate-income households, and that's an issue with their spending.

The last data we had for South Carolina, they were the fastest growth state by jobs in the nation. So, there's a lot of demand generated from the job growth.

Within that, certain sectors are doing well: manufacturing, pharmaceutical construction and new facilities are just going gangbusters in the Carolinas. I hear a lot of broader optimism from the commercial real estate folks as well. Housing and homebuilding is a little bit more muted in some other areas, but generally it's fairly positive in the Carolinas.

Sablik: Picking up on that thing you mentioned, Matt, about job growth, one of the pillars of the Fed's dual mandate is the labor market. What are you all hearing about the labor market, and jobs and employment generally.

Martin: Probably the majority of firms that I've talked to this last cycle are managing headcount. That is, they're not hiring a lot and maybe they're letting headcount drift lower as they have some attrition and perhaps selectively hiring for key roles, that sort of thing.

But I did pick up a number of firms' reports this last cycle where it feels like they might be starting to turn the corner. They're planning for 2026. They can see the demand is strong enough that they might have to hire going into next year and they have to plan around that.

Some are going to be winners from tariffs and trade. They're going to be some losers and they're cutting jobs. But I talked with one firm that's a machinery producer and they think the "build local for local" trend that we're starting to see could really escalate their demand. So, they have plans for next year to undertake a hiring wave.

Now that's the extreme. But I think we're seeing in some places that — particularly in small towns where you might have a larger manufacturer or other employer — they're still trying to get caught up on hiring from the last couple of years as well. So, it's mixed. It's still a lot of caution, but I am hearing that hiring could be better heading into next year than maybe we thought a couple of months ago.

Haltom: If you look at job growth in the Fifth District and, in particular, how states have recovered from COVID, you've got Virginia that really tracks right along with the U.S. economy. The Carolinas, as Matt said, are up on the much higher end and the northern part of our district is more on the lower end.

Echoing a little bit about what Matt said, the labor market has clearly slowed. For the most part of this year, we've been in what we've been calling a "low-hire, low-fire" equilibrium, and it really still feels like we're there. Firms feel pretty cautious about hiring, from what I'm hearing, but the good news is that very few firms talk about layoffs at this point either. They're really not anxious to lose the workers that they have.

I'd probably say the labor market risks feel tilted toward the negative among the firms that I've talked to. I've heard a few more firms recently talk about having to find work to keep people busy. Some have mentioned that they could grow substantially more before needing to add people. But that's still restricted to just a couple of examples and firms really still aren't anxious to lose workers.

An interesting wrinkle is that the state of the labor market and this low-hire, low-fire equilibrium is countered somewhat by changes in immigration policy and data center development, in particular in Virginia. Both of those factors are sort of tightening things in different ways. But, so far, that still feels limited to the sectors that are directly affected. On the immigration side, you hear about it in construction and in agriculture and even in some manufacturing sectors. On the data center side, you hear about it in construction and in manufacturing any components to data centers.

Bauer: I would agree with everything that Matt and Renee said. We're very much in a low-hiring, low-firing equilibrium. Firms are having an easier time finding and keeping workers.

There are special exceptions, like Renee mentioned, where you do have firms that are seeing stronger demand — like I mentioned earlier, these engineering firms that are doing a lot of infrastructure work.

I would agree with Renee that if there's a risk, it's more tilted toward the downside in the Washington area, reflected by the concerns about the impact of cuts to federal employment and federal spending. A lot of the talk in the Greater Washington area is the number of employees that are being let go. Where are they going to go? There [are] a number of federal employees that decided to take the package and stop working for the federal government at the end of September. So, there's a lot of questions about what's happening with labor supply in the Greater Washington area, and what that means for the overall strength of the labor market.

Sablik: Turning to the other side of the Fed's mandate, what are businesses saying about prices, both the costs of their inputs and any price changes that they anticipate making for their own products and services?

Haltom: I can take this one first.

When you talk to firms about prices, tariffs still reflexively dominate the conversation. I think that makes sense. They're a new wrinkle that firms are still figuring out this year, whether they're directly affected by tariffs or it's more indirect. But not a lot has fundamentally changed there. Firms are gradually passing on tariffs where they can, but it's a slower process. It's easier to do on the B2B side — if your customers are other businesses. Whereas, if your customers are consumers, the pushback is pretty fierce.

On the cost side, more recently, one thing that has stood out to me is insurance and health costs. On the insurance side, the number of firms who mentioned costs rising has been kind of staggering to me. Whether it's a meeting with a CEO or people nodding their heads when you're giving a presentation or grabbing you afterward to tell you what they're seeing with regard to insurance costs, it's coming up everywhere again the way it did in 2022. When you ask details, it feels pretty across the board — from property and casualty insurance to workman's comp to liability. A lot of firms also are bringing up health care costs. This is especially noteworthy after the wage increases we've had in recent years, which have led some firms to find non-financial ways of attracting and retaining employees, including by making their benefits really solid.

Insurance and health care costs, of course, matter because the most stubborn part of inflation has been on the services side. This doesn't necessarily bode well for those prices coming down soon.

Martin: Very similar comments on insurance costs across the board. And I agree with everything Renee just said.

I'd just add [that] on the wage growth side, it's still not back to pre-COVID levels. When you talk to firms, the availability of labor is better than it was. In pockets, it's still difficult to find workers. But wage growth, rather than being 3 or 3.5 percent, feels a little bit higher, like 3.5 or 4 percent. Some of that might be because inflation is a little bit higher. Productivity might be good. But firms seem OK with putting out wage growth that's a little bit faster than it had been in the past.

Bauer: Yeah, I would agree with everything that Renee and Matt said. I think Renee covered the tariff issue very well. When you talk to firms, particularly consumer-facing firms, they're still trying to navigate how they're going to handle the increase in costs.

I talked with a couple of businesses this cycle, and what they shared was increased tariffs on a couple of their goods. They went ahead and found alternative sources for that particular good. On top of that, their new supplier was willing to bear some of the cost of the tariff. So, instead of a 50 percent increase in the price of the good, they just get 7 or 8. In another case, a business just decided not to carry certain items because they weren't able to find alternative sources. They knew at the new price point it just wasn't going to work with their customers.

Sablik: As we've been talking, you each covered different parts of the Richmond Fed's district. There's definitely been a lot of agreement in this conversation, a lot of things that are similar, but also some hints of things that are different. I'm wondering, if we pull back and take a big picture look, what are some of kind of the unique challenges or bright spots in each of the areas that you're covering?

Bauer: What is happening in my area of the district is somewhat unique, just because we're so close to Washington, D.C. A lot of the changes that have happened this year, which will reverberate into next year, are related to changes in the federal government.

Haltom: I'd say in Virginia, it's a pretty diverse economy. That's part of the reason that it tracks the overall United States well. We've been seeing population growth. We've been seeing people move in and we've actually been seeing people moving even to the smaller towns and exurbs in search of more affordable housing. Quality of life is generally high in Virginia, so that has been a bright spot. And then, of course, all of the data center activity tends to lead to a feeling of growth and robustness and vibrancy that I hear when I'm out traveling in the district.

If there's more of a concerning spot in the state of Virginia, I think it would be tied to the federal government sector. We're always very closely tied through the professional and business services sector. That is where a lot of the government contracting work lives. That is a segment that is somewhat more concerned right now and has been losing some jobs.

Martin: For the Carolinas, we don't hear a whole lot about the federal government shutdown or impacts from budget. There were some impacts earlier this year. Some nonprofits that had USAID grants and some of the universities have trimmed their payrolls. But it's coming amid pretty broad-based job growth across the two-state region, so it gets lost in that.

I think it's important to note that it is uneven growth across the state. We've got urban centers that are where most of that growth takes place. You can get to some rural areas and smaller towns that aren't doing quite as well, but some of those are doing well also.

I think it'll matter if the federal government shutdown continues and the military miss a paycheck. We've got some communities, particularly toward the eastern parts of both states, where that will matter quite a bit. But until that happens, I don't think we'll hear a whole lot.

Outside of that, concerns about policy uncertainty probably are universal, so that's probably similar and trying to manage through that.

Finally, I do hear a lot of firms talk about workforce — not finding it [but] worried about quality and productivity. We're several years past COVID. Trying to get back into the office has been a difficult thing. Managers want their employees to be together. They think they'll be more productive in the office and interacting.

I think we're getting to the point where some firms are worried about, "How do we get our employees from entry level to that next level where they're more productive?" Everybody wants to talk about how AI is going to play a role in all that process. Heading into next year, most firms seem to have AI as part of their planning.

Sablik: That's a great segue to my last question, which is what are you hearing from firms about their expectations looking ahead to 2026?

Bauer: Business expectations in the Greater Washington region, clearly, [are] less positive. The year started with a great deal of uncertainty and started the fourth quarter with another layer of uncertainty. Given this environment, many of the businesses are just hoping that activity will hold up and things will settle in 2026.

Outside of the Greater Washington area, businesses are more positive. Things are still moving forward, despite having such a challenging year. For many, things turned out better than expected and [firms] are looking for an improvement in 2026.

Haltom: I think one of the best ways to think about this is with respect to the private sector forecasts that are out there, or even the forecasts of Fed policymakers. Most are seeing growth that is roughly at or slightly below trend into 2026. But if you look at the error bands around that, they're really wide. When we are out talking to businesses, it's really those error bands of uncertainty that you hear a lot about.

There is a feeling of pervasive uncertainty going into 2026. I'm hearing more concern about how the health of the consumer will hold up. For a lot of this year, forecasts have been expecting the consumer to slow down, but that has kept not happening.

We've also seen that the lower-income consumer has really been pulling back, with the higher-income consumer carrying more of the spending. There is some concern about how much that's going to persist. Consumer sentiment is relatively low. Consumers are feeling the impact of higher prices. They're a little more worried about the labor market.

I've talked with two firms in recent weeks that talked about the health of the higher-income consumer and how, after a stock market decline like what we saw on Oct. 10, right afterwards, higher-income consumers' sales fall off a little bit. They might come right back, but the point is there's a little bit of vulnerability out there that firms are watching and are a little bit concerned about.

But with all that said, economists have been predicting a slowdown for most of 2025 and it has kept not happening. If the labor market stays stable and the consumer continues to spend, then the outlook for 2026 looks pretty good.

Martin: What I'm hearing is very similar to what Renee just discussed. The baseline outlook is for growth into 2026. But there is a lot of uncertainty around that and I think firms probably want to err on the side of caution, both in hiring and investing.

As the former Charlotte director said coming out of the Great Recession, uncertainty has a shelf life. At some point, if demand holds up well, you've got to react to it. Firms are going to have to hire some, they're probably going to have to think about using some of the resources they have to put capital to work. The interesting thing to watch heading into next year is if growth holds up, when do firms come off the sidelines and start reacting to what they're seeing in the marketplace day to day?

Sablik: Andy, Renee, and Matt, thank you so much for joining me today to share what you're hearing.