October 27, 2004
Federal Reserve Districts
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The Seventh District economy continued to expand at a moderate pace in September and early October. Consumer spending remained relatively soft, while business spending continued to firm. Overall construction and real estate activity again was robust, although some further slowing was apparent on the residential side. Manufacturing expanded solidly. Loan demand from households eased since our last report, while business loan demand picked up. Input costs remained high and wages were trending up, but retail price increases were largely constrained by fierce competition. Crop conditions have improved since our last report, and the District's corn and soybean harvests could set records.
Contact reports again were mixed, but on balance suggested that consumer spending remained somewhat soft in September and early October. Retailers generally indicated that recent sales results came in at the low end of their expectations, if not below. Once again, national chains suggested that the Midwest was one of the weaker performing regions. Some contacts blamed unseasonably warm weather for slow sales of fall and winter apparel, although most expected these sales to be recouped when temperatures cool. Retail inventories were reportedly in good shape heading into the holidays. District auto dealers indicated that light vehicle sales fell off in early October, after surging toward the end of September. Strong September sales helped bring excessive inventories down to more desirable levels for many dealers. Most were cautiously optimistic about sales for the remainder of the year, and were ordering light vehicles accordingly. Tourism and related spending were largely unchanged since our last report, at levels slightly above those of a year-ago. Many contacts said that high oil prices and uncertainty surrounding national elections may be lowering consumers' confidence and delaying purchases.
Business spending rose again in the latest reporting period, with more firms noting increases in capital spending. Some contacts said that special factors, such as changing environmental regulations and expiring tax incentives, contributed to higher capital outlays. Trucking and rail companies continued to boost capital spending as freight volumes trended even higher. Airline contacts noted that bookings for business travel remained strong, particularly on international routes. A printing company contact said that orders from advertisers had risen somewhat over the past few months. With regard to hiring, one large temporary help firm indicated that year-over-year growth in billable hours had fallen considerably in September, but appeared to be rising in early October. Much of the weakness in September was in lower-skilled positions; demand for professional and technical workers remained very strong. Several temp help contacts said that permanent placements continued to rise. More manufacturers indicated that they had recently hired, or planned to hire, additional workers in response to strong demand for their products. Outside of manufacturing, there were scattered reports of permanent hiring. Although outright worker shortages remained few, several contacts said that they were receiving fewer applications for open positions.
Overall construction and real estate activity remained robust. Realtors and builders continued to portray the housing market as solid. However, several noted that residential activity appeared to slow more than they had expected. A Realtor in one large market said that September's sales had come in below year-earlier levels for the third straight month, something that hasn't happened in a long time. Moreover, the number of homes listed for sale had been moving lower as well. While most contacts maintained a bullish outlook for home sales, they had become more concerned by the recent slowing trend. On the nonresidential side, office leasing activity seemed to pick up in recent weeks. One contact said that net absorption of office space in some areas turned positive after an extended period of being negative. However, vacancy rates may remain elevated as new space is expected to come into the market in coming quarters. Retail development and leasing activities were again robust. By contrast, contacts noted some slight softening in the light industrial segment.
Manufacturing activity expanded solidly, and strength was widespread across many of the District's key industry segments. Production and orders were strong, and some contacts noted more "forward-looking orders" that, if sustained, could lead customers to expand their production capabilities. One producer of machine tools was particular pleased with the "depth of buying," noting that the firm was getting orders from customers it had not seen in two or three years. Production, shipments and orders for heavy equipment (agricultural, construction, mining) remained strong. This activity, and other factors, continued to boost the demand for steel. Contacts were expecting steel prices to remain high in coming months, so some users, such as steel service centers, were no longer delaying steel purchases in anticipation of lower prices. Meanwhile, steel mills could not boost production fast enough to keep up with demand. One producer of home appliances also noted that continued strong demand was making it difficult to build inventories. Nationwide, light vehicle sales picked up markedly in September, which helped bring bloated inventories down to more manageable levels for some makes and models. More generally, manufacturing contacts suggested that domestic producers were benefiting from a relatively weaker dollar and higher shipping costs, both of which have increased the costs of imported goods.
In a reversal of recent trends, lenders reported some softening in household loan activity, but a modest pickup in business lending. Nearly all of our banking contacts reported a slowdown in residential mortgage loan applications, for both purchases and refinancing. Reports on the demand for other types of household loans (home equity, credit card, etc.) varied. Standards and terms on household loans were largely unchanged and credit quality continued to improve. A few bankers reported a long-awaited, albeit modest, increase in business lending activity. One contact said that business loan volumes had increased in September, after several months of virtually no growth. Still, the increase in business loan volumes fell short of the bank's plans. Another contact reported that borrowing for operating expenses picked up modestly, but demand for capital spending loans remained weak. All of the bankers contacted reported that competition for business loans remained intense. None of the banks contacted said they were relaxing covenants, although margins were being squeezed. Business credit quality continued to improve, allowing many lenders to reduce contributions to their loan-loss reserves.
Input prices remained elevated and employment costs edged higher, but retail price pressures still were largely subdued. Persistently high steel prices have led more and more firms to accept surcharges on steel products. Higher energy costs continued to alter business plans. Freight haulers were able to pass along higher fuel prices amidst what one contact called "the best pricing environment" for the industry in the last 20 years. By contrast, airlines have been unable to raise air fares, and some said they will need to cut labor costs further to offset higher jet fuel costs. More generally, however, contacts suggested that wages were trending slightly higher in the latest reporting period. There were also scattered reports of firms paying hiring and retention bonuses, after several years of absence. One temporary help firm said that higher taxes for unemployment insurance, and already tight margins, will force the firm to raise prices in 2005. Despite cost pressures elsewhere, retail price increases were in large part subdued by fierce competition.
Crop conditions have improved since our last report, and the District's harvests of corn and soybeans could set records. Crop maturation was aided by warmer-than-typical temperatures in September. This allowed late-planted fields to catch up, especially in some northern portions of the District. Corn and soybean prices dipped again, although corn sold to ethanol producers garnered a price premium. Many farmers were leaving corn in the field longer to reduce moisture content and minimize drying costs at elevators, and many have decided to store their crops in the hope of higher prices later. Contacts in Illinois and Indiana said that rail and truck capacity constraints were pushing shipping costs higher and delaying crop shipments. With high crop yields, government payments, relatively low interest rates, and little land on the market, farmland values continued to rise.