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The Seventh District economy remained strong, but the pace of expansion moderated further in April and May. Consumer spending growth softened notably and many retailers suggested that sales results in the Midwest were not as good as in some other regions. Growth in construction activity slowed slightly again, but both residential and nonresidential activity was described as strong. While production generally remained robust, manufacturers reported more mixed conditions. Lenders reported solid, steady loan demand from businesses, but moderately softer demand on the consumer side. Worker shortages and wage pressures persisted in the District, but neither showed signs of intensifying over the last two months. District farmland values rose 2 percent during the first quarter. Corn planting was essentially complete and topsoil moisture levels improved with timely rainfall in recent weeks.
Consumer spending in April and May softened noticeably in many key segments. Retailers, both discounters and general merchandisers, generally reported that sales fell short of their expectations, in part due to unfavorable weather. However, sales of home-related items (such as appliances, electronics, and home furnishings) remained strong as did sales of ladies apparel and jewelry. In contrast, results for seasonal items were mixed, with sales mostly described as soft. Retailing contacts with a national presence generally indicated that sales in the Midwest were softer than in the nation as a whole. Despite generally weaker-than-expected sales results, there were few signs that inventories were building. The casual dining business remained strong, although one contact noted that business softened slightly in April and moderated a little further in May. Several District auto dealers reported a discernible sales slowdown in recent weeks, with a contact at one large auto group citing higher gasoline prices and interest rates as contributing factors. This contact also noted that inventories were well above the group's desired levels, and that costs of maintaining that inventory cut profit margins significantly. While overall price increases at the retail level remained modest, there were more frequent reports that higher fuel costs were pushing up prices for distribution and travel & tourism-related services.
Construction and Real Estate
Overall construction activity slowed modestly in April and May, but most contacts continued to describe the market as strong. Sales of both new and existing homes were off from year-ago levels in much of the District, although no one was "singing the blues," according to one contact. A leading realtor in one of the District's largest metro areas said that while May's existing home sales were off significantly from year-ago levels, it was still the second best May ever. Some contacts indicated that higher mortgage interest rates had taken many first-time buyers out of the market. One contact suggested that this was beginning to have a "trickle-up" effect; that is, when low-end homes do not sell, the owners of those homes cannot move up to a bigger home. A suburban architect noted that some clients were scaling back residential remodeling plans somewhat and pressing for quick turnaround on drawings so permits could be obtained and financing locked in before interest rates moved higher. Nonresidential activity remained strong, although contacts suggested that growth may have slowed somewhat in recent weeks. One retail contact pointed to more contractor bids on their expansion projects (compared to a few months ago) as a sign of some softening in the commercial building segment. There were some reports that public projects, which contributed significantly to overall growth earlier in the year, had softened slightly in recent weeks. Generally, however, contacts suggested that nonresidential construction activity was strong and fairly steady, and most remained confident that the supply of commercial space was in line with demand.
Conditions in the manufacturing sector became more mixed in recent weeks as the region's star performer, its auto industry, showed some signs of slowing. Nationwide, light vehicle sales fell in May, the first year-over-year monthly decrease since August 1998. However, auto analysts pointed out that sales were still very strong, around 17 million units at an annualized rate, and suffered only in comparison to last May's exceptional sales results. The region's steel industry continued to run near capacity, despite sluggish new orders from the industrial segment, as demand remained strong from the construction segment--particularly for government projects (schools, highways, etc.). One analyst noted that there was some inventory building in the first five months of the year as buyers stocked up on steel products ahead of an announced price increase. Reports from manufacturers of heavy equipment were mixed. Orders for agricultural equipment picked up slightly from very low levels, while orders for heavy trucks and construction and earth-moving equipment decreased. Equipment producers noted that demand from European markets was picking up while the domestic market was sagging. A producer of communications equipment reported strong orders and rising backlogs, while also indicating that most of the strength in demand was coming from overseas. Most manufacturers reported that the pricing environment remained very soft. One contact noted that gypsum wallboard prices, which had been relatively firm, slipped recently as new capacity came on stream.
Banking and Finance
Overall lending activity was again strong, although some contacts indicated that growth had flattened out at high levels. Home-equity lending was robust during April and May, just as new mortgage applications slowed noticeably. One contact noted that demand for adjustable-rate mortgages, which had picked up earlier as rates on fixed-rate mortgages increased, softened in recent weeks. Consumer loan quality was generally described as good and steady. Business loan demand remained strong, although most contacts suggested that loan growth had flattened out. There were some indications that lenders in the District were tightening their standards on commercial loans, with one banker suggesting that nearly all banks were taking a closer look at deals, particularly for commercial real estate loans. The quality of outstanding business loans remained high, with a large money center bank reporting that the level of non-performing loans was "extraordinarily low."
Contacts reported very little change in tight labor market conditions in recent weeks as strong demand, worker shortages, and wage pressures persisted. In addition, a survey of hiring plans suggested that employers in the Midwest expected to continue adding to their payrolls, signaling that labor markets will remain tight in coming months. While shortages of qualified workers were widespread, they were particularly severe in the trucking and retail industries. A large transportation company noted that a dearth of drivers led to a double-digit increase in the mileage rate paid to drivers in February, and may lead to further increases in June. Contacts in the retail industry also reported that finding and retaining workers remained difficult. While overall wage pressures were relatively stable, a contact in casual dining indicated that employment costs were up 4 to 6 percent from a year ago. This contact also noted that wage gains had recently begun to outstrip increases in productivity. There was virtually no evidence, however, that higher wages were translating into higher prices at the retail level.
Our survey of agricultural bankers showed that District farmland values rose an average of 2 percent during the first quarter (i.e., from January 1 to April 1), with all five District states registering an increase. Average cash rents were little changed from last year, though bankers in Michigan and Wisconsin reported a modest increase. Farm loan repayments continued to be a concern during the first quarter. This encouraged farmers and bankers to increase their use of farm loan guarantees from the Farm Service Agency. Over three-quarters of surveyed bankers indicated they were making some use of these guarantees. Corn planting in the District was essentially finished at the end of May, well ahead of the average pace. Soybean planting also neared completion. Crop prospects improved in late May as timely rains replenished topsoil moisture throughout the District, although dry conditions were still a concern in much of Iowa. Some areas of Wisconsin reported crop damage due to a frost in late May.