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Seventh District--Chicago

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Economic activity in the Seventh District remained sluggish in June and the first half of July. Contacts generally were still optimistic that the economy would pick up in coming months, though more voiced concerns that weak labor markets may constrain growth. Consumer spending was again relatively subdued, and business spending and hiring remained weak. Residential real estate activity held strong while nonresidential markets were still soft. Conditions in manufacturing improved slightly, in part due to a weaker dollar. Banks continued to report robust residential mortgage lending, but business loan volumes were again flat. Relatively soft demand and fierce competition limited upward pressure on prices, while labor costs were being pushed higher by insurance and tax increases more than by rising wages. Corn and soybean crops generally were in good-to-excellent condition.

Consumer Spending
Overall, consumer spending remained lackluster in June and early July. Many contacts suggested that consumers have become increasingly concerned about the weak job market and were maintaining tight control over their outlays. There were reports that consumers were putting off discretionary health care spending and trading down on some nutritional products, such as baby formula. Retailers reported using more and steeper discounts to help meet sales expectations. Auto dealers in the region said that new vehicle sales were relatively soft in recent weeks, and inventories were still high. Several contacts complained that manufacturers' layered incentives were confusing consumers and making it difficult to market vehicles. With weak used car prices, more dealers appeared to be sending trade-ins directly to auction rather than paying for floor planning, insurance, and repairs. Tourism held firm in many areas, and hotel occupancy rates rose in some. Contacts said that discount and economy packages were helping to boost District travel.

Business Spending
While businesses were more optimistic about the economic outlook for the second half of the year, they remained very cautious in their spending and hiring. Current capital expenditures changed little since our last report, as decisionmakers continued to take a wait-and-see attitude. One contact said that maintenance outlays were taking place, but not much capacity expansion. Firms appeared reluctant to build inventories until a sustained pickup in demand was more evident. More stringent purchasing practices (such as extensive approval processes) were also said to be hindering business spending. With few exceptions, demand for labor softened in late June and early July. Temporary help firms said that growth in billable hours was weaker entering the third quarter than at the start of the second, with year-over-year growth rates firmly negative in early July. One contact in temporary help said, "Whatever is happening in the economy right now is not creating jobs." Citing the apparent disconnect between an improvement in businesses' expectations and their actual hiring, another contact suggested that decisionmakers "no longer trust their own intuition."

Construction and Real Estate
Real estate markets remained mixed. Sales of both new and existing homes were very robust in June and early July, according to Realtors and builders. Most contacts attributed this strength to very low mortgage interest rates. Commercial real estate and construction activity was still soft. Reports from the office sector were mixed. One contact noted that property showings tailed off recently, after picking up in April and May. A large property holder in the Chicago area said that a survey completed in mid-July showed that tenants were still more likely to downsize than to expand. While there were a few isolated reports of new demand, on balance, the bulk of office leasing activity was still driven by renewals and renegotiations. Office rents remained under downward pressure. The industrial real estate market was reportedly "holding its own," even though manufacturing vacancies were increasing in some areas due to firms closing and/or relocating. Big box retail development was said to be slowing, with fewer projects in the pipeline. However, development of some types of freestanding retail space (banks, pharmacies, etc.) remained strong.

Manufacturing activity improved slightly in June and early July. Automakers indicated that sales of new light vehicles were "pretty good" for the nation as a whole through mid-July, and added that June's pickup to 16.3 million units (seasonally adjusted annual rate) was partly due to stronger fleet sales. Light vehicle inventories remained elevated in mid-July. However, automakers did not necessarily view these stocks as excessive given model-year changeovers and labor contract negotiations. A major producer of heavy equipment reported that new orders edged up recently, due in part to the weaker dollar, and dealers also noted that requests for price quotes had increased over the last month. A contact with a large telecommunications equipment manufacturer said that he was seeing "decent signs of a recovery in the industry-not robust, but improving." Some small manufacturers in the District were also seeing improvements, with increases in requests for price quotes and even some new orders. Steel demand was still soft. Inventories at steel service centers were down from May, but remained on the high side. By contrast, contacts said that inventories in some other industries were so low that any new orders would have to be met by increasing production.

Banking and Finance
Lending activity was still mixed, with strong household borrowing and weak business demand. The strength in household lending was again driven by mortgage demand. New mortgage originations remained brisk with the active housing market. Many bankers said that refinancing applications retreated somewhat in July, though they remained near record levels. The benefits of refinancing were said to be limiting growth in other household loan segments, such as home equity and credit card. There was little reported change in household delinquencies and defaults, which generally were within acceptable ranges. On balance, business loan volumes were flat. However, within each market segment-small, middle-market, and large-reports on loan demand were mixed. Merger and acquisition (M&A) activity continued to pick up modestly. One contact said that banks had been looking for M&A deals, but buyers and sellers had been hesitant to get together until recently. Business loan quality was generally described as good.

Prices and Employment Costs
There was little change in the pricing environment in June and early July. Contacts generally suggested that soft demand and fierce competition left them with little pricing power, although there were a few exceptions. State universities in Michigan were raising tuitions by 9 percent to 14 percent in order to offset cuts in state appropriations as well as increases in health care and utility costs. A few manufacturers noted that output prices were firming, in part due to a weaker dollar. Wage pressures remained largely subdued, but some contacts cautioned that higher health insurance premiums, state unemployment taxes, and workers compensation costs were pushing overall labor costs higher. One large temporary help firm suggested that the "true cost of labor to a company is going up faster than in prior years, even with smaller to no merit increases." Negotiations between the United Auto Workers and automakers got under way in mid-July, and talks were expected to focus on health insurance and excess production capacity.

Corn and soybean acres were in good-to-excellent condition in most of the region after recent rains, although heavy storms damaged crops and flooded fields in some areas. Crop and livestock prices continued to be relatively high compared to the last several years. Nonetheless, not all farmers have been able to improve their balance sheets, in particular dairy farmers and those who have large cash rent operations. Due to very low dairy prices, many smaller operators were considering whether to shut down and pursue off-farm employment. Contacts indicated that farmers generally remained cautious and had not increased spending on equipment and capital improvements, though that might change if yield prospects turn into "crops in the bin." Farmland values rose again in the second quarter, in part reflecting lower interest rates, limited acres for sale, more of a presence by outside investors, and ongoing development. However, several bankers expressed reservations about the sustainability of current land values, especially when interest rates rise.

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Last update: July 30, 2003