June 14, 2006 Federal Reserve Districts Eleventh District--Dallas

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Eleventh District economic activity continued to expand quite strongly from mid-April to early June. Energy activity is still very robust, and both the manufacturing and service sectors report continued strong activity. Construction and real estate activity remained brisk, but there was a noticeable dip in the market for lower priced homes, particularly in Dallas and Fort Worth. Retail sales growth weakened slightly. Financial service contacts continue to report favorable conditions. Spring rains have improved agricultural conditions, but parts of the District remain very dry, and drought has damaged some production. Rising costs pushed up selling prices for many industries. Prices Prices are higher for a number of inputs, including crude oil, fuel, chemicals, paper, packaging, metals and transportation. Some retailers and most manufacturers said they had passed cost increases through to higher selling prices. Service sector firms also report they are charging higher prices. There were a few reports of price declines, most notably for natural gas. Prices are higher for most construction-related manufactured products, but prices fell for a few products used in homebuilding. Builders say rising construction costs are a growing concern because stiff competition is making it difficult to increase prices. Crude oil prices hovered around $70 per barrel during the period boosted by concerns that political tension and terrorism could lead to supply disruptions. The recovery of refinery capacity along the Gulf Coast helped push oil demand back up to normal ranges, but consumption remains on the low side of the 5-year average, and inventories of crude are well above historical levels. Gasoline prices in the District increased at the pump throughout most of the period, rising to near $3 per gallon in mid-May. Inventories of reformulated gas fell to very low levels as the industry changed to ethanol-based oxygenates. The change appears to be nearly complete, but ethanol is in short supply and a series of refinery outages has kept markets nervous. Mild weather reduced demand for natural gas, and inventories increased to 55 percent above normal for this time of year. Prices fell from $8 to $6 per million Btu at Henry Hub. Prices would have fallen further if not for rising crude prices and the coming hurricane season. Prices are higher for most chemicals. After falling through March and April, major plant outages pushed up ethylene prices in May. Higher ethylene prices, low inventories and a boost in demand pushed up polyethylene prices. Propylene, which can be used the production of gasoline, rose along with prices at the pump. Polypropylene prices were also up. Polyvinyl chloride prices were lower, which contacts attributed to weaker sales to homebuilders. Labor Market The labor market continues to tighten, with reports of increased hiring in manufacturing and services. Firms are reporting more difficulty finding workers, and more contacts say that it is necessary to increase wages to obtain or retain employees. Shortages are mostly for skilled positions, such as for truckers, lawyers, accountants, financial analysts, high tech engineers and workers to supply the energy industry--especially welders and engineers. Temporary service firms say it is harder to find qualified workers, particularly since their customers are resisting wage increases. There has been an increase in the number of direct hires and temp-to-perm hires, which they say reflects the confidence their clients have in the growth of the economy. Manufacturing Manufacturing activity remains strong. Demand continued to be robust for most construction-related products, including metals, cement, stone, clay, brick and glass. The majority of producers said demand was still strong from residential homebuilders, but producers of lumber noted some weakening. Still demand remains heavy to supply lumber to commercial builders. The paper industry reported stronger demand for products, particularly to supply schools and hospitals. Sales of food and apparel products were unchanged. The high-tech industry reported continued good growth. Semiconductor producers said demand was up, and one firm reports that their bookings are stronger than revenue. Most respondents said inventories are at desired levels, and prices are firming. Refinery capacity utilization along the Gulf Coast returned to 90 percent for the first time since the hurricanes, primarily due to the return of three large refineries (two in New Orleans and one in Houston). The return from spring maintenance continued to be slower than expected. The chemical industry also continues to recover from the hurricanes. Contacts say demand for plastics is probably being helped by some precautionary inventory building before the hurricane season. Services Temporary staffing firms report steady activity, up significantly from a year ago. Law firms say demand for their services has been steady, and accounting firms say activity levels are typical for this time of year. The transportation industry continued to report strong demand. Rail volume has been very strong, boosted by shipments of coal, coke and metals. Activity in the trucking and airline industries also remains strong. Retail Sales Overall retail sales growth weakened slightly since the last Beige Book. Reports from retailers were very mixed, with some reporting very good or extraordinarily strong sales, while others reporting that sales were soft or disappointing. Sales continue to be weakest at stores selling to lower-income customers, who are spending a larger share of their disposable income on gasoline and energy utilities. Consumers appeared to be changing their buying habits to accommodate rising prices and higher gasoline costs. Retailers say customers are making less frequent visits to the store and switching to stores that are closer to home. Auto sales increased seasonally in most markets, although sales in Dallas were unchanged. Some dealers report sizable excess inventory because demand was less than anticipated during the winter months. Contacts expect the recent increase in rebates and other incentives to boost sales. Construction and Real Estate The housing market softened slightly following very strong growth over the past year. Sales of existing homes are still brisk in Austin, El Paso, Houston and San Antonio, but sales weakened in Dallas and Fort Worth. Demand for lower priced homes has dipped noticeably in several markets, which contacts attribute to higher interest rates, rising energy costs and tighter lending standards. Overall, industry leaders say residential real estate activity is solid at very high levels, but they are quite nervous about the market being affected by press reports of a possible fall off in housing prices. Demand for apartments remains strong, and occupancies are increasing in most markets, but rents are not firming as expected. A notable exception is in Houston where hurricane evacuees continue to stimulate the market, particularly for Class B and C properties. There is growing concern about overbuilding of condominiums and town homes in Dallas, and contacts fear that it will end badly. Demand for office space continues to edge up at a steady pace, with rents firming. Contacts say retail markets remain healthy. Demand for industrial properties is gradually improving. Financial Services Commercial loan demand remains steady, according to lenders who say there continues to be competitive pressures on pricing. Commercial lenders are very optimistic about the future and say loan quality is still very good. Respondents lending to consumers say borrowing remains steady, and credit quality is good. Energy The Texas rig count continues to rise rapidly, with most of the drilling on land and directed toward natural gas. Two rigs were added in the Gulf of Mexico over the past month, but rigs continue to leave the Gulf because drilling in other locations is more profitable and the approaching hurricane season has pushed up insurance premiums. Recent weakness in natural gas prices has not curtailed exploration according to contacts. Some drilling for natural gas could become unprofitable if current prices persist or weaken further, but the futures market shows stronger prices by late fall. The current surplus of natural gas in storage could disappear quickly with a hot summer or a hurricane-related disruption of supply. The industry's expansion is still being constrained, mostly by shortages of labor. Strong demand and rising prices for inputs, including commodities and labor, are pushing up prices of oilfield services. Agriculture Spring rains have improved planting, range and pasture conditions in some parts of the District. Other areas remain very dry, however, and herd reduction continues. Drought damaged the winter wheat crop, and production was down 65 percent from last year. Cotton and grain sorghum crops in South Texas have also been damaged, and producers are collecting insurance on these crops. Return to top Kansas City San Francisco