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Federal Reserve Districts

Eleventh District--Dallas

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Eleventh District economic activity grew quite strongly from mid-July to late August, but there were more pockets of softness than in the last report. The energy industry is still expanding as rapidly as possible. Service sector activity is strong, although a few contacts noted some possible signs of weakness. Manufacturing activity is high but continued to cool. Real estate activity remained robust. A slight slowing in residential activity was offset by swelling nonresidential building. The financial services industry reported good overall credit quality, but consumer lending has weakened some. Agricultural conditions are still very dry.

In general, contacts blame recent pockets of softness on weakness in national housing markets and on high gasoline and electricity costs, which have dampened consumer spending. Several respondents said they have recently become more cautious about the outlook for activity, and some firms were adjusting inventory management or business plans to be more cautious about the possibility of additional slowing growth.

Price pressures were mixed. Crude oil prices have been high and volatile, pushed up by strong demand, supply disruptions and geopolitical fears. The price of light sweet crude oil peaked at $77 per barrel during the period, an all-time high in nominal dollars, and then decreased to near $70. Natural gas prices strengthened during the period, pushed up by strong demand for electric power generation, but high inventories are keeping natural gas prices low relative to those for oil. High shipping and energy costs continued to squeeze profits and put upward pressure on selling prices for most industries. Fuel surcharges have escalated, according to contacts, who say firms are passing these to selling prices as much as possible. There were also reports of increases in some raw materials prices. Real estate prices--including median home prices--continued to rise at a modest pace. In the high-tech sector, some prices were falling more slowly than normal, because rising raw material and transportation costs were being passed to customers. Farmers and ranchers reported soaring fuel, fertilizer, seed and irrigation costs.

Some prices were lower, mostly as a result of weakened demand. Some retailers said stiff competition had resulted in larger markdowns. Prices were lower for a few construction-related inputs, such as steel and aluminum. Gasoline prices remained high but are trending downward, with the average retail pump price falling under $2.70 per gallon in late August.

Labor Market
The labor market continued to tighten. At the same time, soft demand led a handful of manufacturers to freeze hiring or consider layoffs. Rising wages are being reported by a growing number of industries, and there are sharp increases for skilled workers that are in short supply.

Reports of worker shortages have become more numerous and, in some instances, more forceful. There are shortages of skilled workers for a broad range of occupations, including in oil field services, construction, accounting, trucking, engineering, and financial services. Non-skilled workers are also increasingly in short supply. A temporary service firm says one manufacturer is hiring workers without experience and paying them minimum wage to undergo training for a few weeks before being accepted as temporary workers.

More contacts expressed difficulty finding workers who can pass drug tests or provide papers proving that they are legal. Concerns about immigration reform have become palpable. A large commercial construction firm said disruption to the immigrant flow is the biggest threat the construction industry has faced in many decades.

Manufacturing activity remained quite strong, but there was some softness in sales of construction-related products and increased concern about slowing demand for high-tech products. Still, energy-related manufacturing remained very robust, including the refinery industry, which has finally returned to normal levels of capacity utilization since last year's hurricanes.

Orders softened slightly but remained quite strong for construction-related products, such as lumber, stone, brick, glass, primary and fabricated metals. Some contacts noted a drop in demand from home builders, with a brick producer reporting a sharp increase in cancellations. Others said orders for nonresidential construction were keeping activity strong. Overall uncertainty had increased, but contacts were optimistic that orders would bounce back, suggesting that the recent slow down in residential construction might be partly due to hot weather.

Reports from the high tech sector were mixed. Demand remained strong for some products, particularly for newer technologies. One manufacturer said that his biggest problem is trying to find additional capacity to fill orders. Demand continued to soften for older technologies, such as lower-end PCs and memory chips. Contacts say it is unclear if orders will continue to slow or are just pausing.

Despite high prices, gasoline consumption was up roughly 2 percent from last year. Demand has also been strong for most major petrochemicals. Renewed exports helped ethylene sales bounce back, as the weakness in natural gas prices relative to oil prices has reopened export markets for U.S.-produced ethylene. Polyethylene and polypropylene plastics have also experienced strong domestic demand.

Paper producers said sales were flat over the past month. Food producers say sales volume has been unchanged.

Activity in the service sector was still strong. Temporary service firms say activity is above a year ago, and demand is broadbased across most sectors of the economy. Accounting contacts say demand for their services is stable. Law firms reported a slight pick up in activity.

Activity in the transportation sector continued to increase, although there was a slight decline in airline bookings and cargo volume. Shipments of construction-related materials dropped off sharply. Traffic volumes for grain also softened because dry weather has weakened crop production. The trucking industry says the outlook has improved because of growing international trade and expansion at the Port of Houston.

Retail Sales
Retail sales continued to be mixed, but overall sales growth was still sluggish and below expectations. High gasoline and air conditioning bills have been absorbing discretionary income, according to contacts, who say that consumers are very price conscious. Retailers have become more cautious about the outlook and say they are buying inventory more carefully.

Auto sales were mixed. Some dealers reported a slight increase in volume but others reported substantial declines. Sales continued to be strong for luxury and fuel efficient vehicles, but sales of pickup trucks have been particularly poor.

Construction and Real Estate
While still at high levels, home sales continued to cool over the past six weeks, especially for lower priced homes. Relocations spurred sales of moderate and high priced homes. Builders reported continued strength in traffic and sales but say it is taking a little longer to close deals. There were a few reports of sales cancellations, mostly because buyers were unable to sell their West Coast homes. Demand for apartments is keeping pace with supply, according to contacts, but many continued to express concern that Dallas condominium construction might overshoot demand.

Contacts say office leasing activity has been strong over the past six weeks, with more requests for larger blocks of space from local firms and relocations. New development has picked up in several areas, especially in Dallas. Respondents say construction is based upon fundamentals, with demand and rental rates justifying the additional space. Other nonresidential segments, like retail, continued to see increased construction activity, but a few contacts said the amount of construction warranted watching. Public construction activity remained robust.

Financial Services
Industry contacts continued to report steady loan demand and deposit growth. Competition for commercial loans and deposits has been intense. Consumer lending activity softened. Contacts say consumers are being more cautious, paying down debt and not taking on additional debt at the higher rates. Overall credit quality remained strong.

The U.S. rig count added over 100 rigs during the period, with two-thirds in Texas. Soft natural gas prices have led to a slight shift in the percentage of rigs drilling for oil instead of natural gas and gave operators a little more leverage in negotiating day rates for land rigs. Day rates have flattened out, but not fallen. The rig count increased slightly in the Gulf of Mexico, and interest in the deep waters of the Gulf is strong. Shallow water rigs continued to leave in favor of higher day rates and lower insurance bills elsewhere in the world.

Demand for oil services and machinery remained strong, with continued large backlogs and limited service capacity. Service firms reported pricing leverage, and said they are building most of their increased revenue supporting strong international activity.

Some contacts are referring to this drought as the worst since the 1950s. More than 50 percent of the cotton, corn, sorghum and soybean crop is in poor to very poor shape. Dryland crops have been written off as losses in many areas, and most farmers are not planting a second crop. Yields for irrigated crops are expected to be lackluster. A lack of water and forage, along with high feed costs, has led cow-calf operators to cull their herds at a higher-than-normal rate. Contacts say the increased number of cattle being liquidated will cut calf production in half next year and severely impact beef supplies over the next few years.

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Last update: September 6, 2006