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Economic activity in the Seventh District continued to expand at a moderate pace during July and August. Consumer spending continued to increase gradually. Business spending and hiring expanded at a modest pace. Residential construction moderated some from high levels, while activity in commercial real estate markets held steady or firmed. Manufacturing activity continued at a solid pace. Lending continued to increase at a moderate pace. Cost and price pressures remained modest outside of energy-related increases. August rains eased drought conditions, leading to higher expectations for soybean yields.
Consumer spending continued to increase gradually during July and August. Retail activity in the District lagged activity in other parts of the country, but retail sales in the Chicago area apparently held up well. One analyst noted that heightened uncertainty in the auto industry had made Michigan consumers particularly cautious. Non-auto retail inventories were little changed in July. Auto dealers in the District said that sales moderated in August due to both a lack of vehicle availability and "buyer fatigue," but sales remained brisk on balance. Dealers were surprised at the strength of light truck sales given recent increases in fuel prices. Inventories of new vehicles were quite lean. However, the strength in new vehicle sales reduced demand for used vehicles and increased the number of trade-ins, leading to a surge in used vehicle inventories. A large restaurant chain noted that demand seemed to be softening, but sales of premium products had improved. Tourism activity in Michigan increased faster than expected, and one contact noted that early bookings for the fall suggest the gains should persist.
Business spending and hiring expanded at a modest pace. In general, contacts reported continued gains in capital spending. A pharmaceutical manufacturer said that its spending on structures was strong, but the firm had increased the rate of return required for new investment projects to get approval. A large transportation firm reported that higher-than-expected fuel costs had led it to invest less than planned and rethink its capital spending plans for 2006. A trucking firm noted that growth in freight volumes was slowing, with an unusual amount of weakness in shipments of consumer goods. Labor market conditions continued to improve gradually. Job gains were reported by firms in the banking, food processing, and pharmaceutical industries. In contrast, a Chicago auto dealer said that it was likely to hold off hiring until next spring. Staffing services firms reported steady growth in hours.
Construction and real estate activity was mixed by location and market segment. Residential construction moderated from high levels, but continued to be brisk on balance. Homebuilders in Milwaukee reported that much of the recent moderation occurred in the mid-price segment, while lower- and higher-priced homes had seen only slight declines in sales. Contacts generally felt that the number of homes on the market was near appropriate levels, though some builders added extra incentives, such as free hot tubs, to keep up interest. Rental unit vacancy rates declined. Activity in commercial real estate markets held steady or firmed somewhat. Demand for small blocks of office space was said to be stronger than demand for large blocks. Office vacancy rates remained elevated, though they improved slightly. A contact in Indiana expected commercial construction to pick up further in the wake of "a few big deals" that were announced recently.
Manufacturing activity continued at a solid pace in the District during July and August. Reports from the heavy equipment industry remained especially favorable, with double-digit growth in construction equipment demand from a year ago and a "hot" sales pace of mining equipment. Equipment inventories were in line with preferred levels. The steel industry recovered from a soft patch experienced earlier in the summer, and one steel firm reported that its order books looked stronger in August. Steel inventories fell but stayed at higher-than-desired levels. Gypsum wallboard orders remained "very strong," as demand for home repair and remodeling reportedly increased. Domestic automakers reported some moderation in nationwide light vehicle sales during August, though sales remained above the year-to-date average; contacts expected steeper declines later in the fall. Demand for heavy-duty trucks softened from strong year-ago levels. One industry analyst said that a smaller portion of customers were ordering trucks for delivery within six months, which could lead to reduced production in the fourth quarter but higher output in 2006. Area tool and die firms reported somewhat slower growth in production, but orders and backlogs remained at good levels.
Lending activity continued to expand at a moderate pace during July and August. Demand for home-purchase mortgages remained strong on balance, though Michigan lenders noted some weaker demand. Refinancing activity continued to slow in general, though one Chicago bank said that its refinance applications were relatively stable because many applicants wanted to move from adjustable-rate to fixed-rate mortgages. A Michigan bank reported it was "looking harder" at the loan-to-value ratios of the mortgages it issues. A mid-sized Wisconsin bank noted "soft" demand for home equity loans and lines of credit. Consumer credit quality in the District was good, with average or low levels of delinquencies. Business loan demand continued to increase, with gains fairly balanced across segments. Business credit quality was good and even improved in some areas. Business customers were said to have strong cash positions, and more than one bank said that business usage of lines of credit was unusually low. Continuing competitive pressures led to reports of easing standards, terms, and/or margins on business loans.
Overall cost and price pressures remained moderate. Material costs rose for energy and some construction materials. Shortages of alloys led to increases in the cost of some specialty steel products, while scrap steel prices bottomed out. Truckers were said to be recovering much of their higher fuel costs, and there were some reports of new fuel surcharges. A local airline said it has not been able to increase the dollar value of its fares enough to fully offset higher fuel costs, but the airline had tightened requirements on discount fares. Higher gas prices required bigger discounts on the largest sport utility vehicles, according to one large automaker. A restaurant chain felt it had a greater ability to increase its prices, while a mid-size retailer was under more competitive pressure to lower prices. Labor cost increases remained modest overall, though one contact noted that recruiters were increasing their fees for the first time in more than four years.
August rains lessened drought conditions in the District and boosted expectations for soybean yields. However, the rains came too late to aid affected corn crops, particularly those in Illinois and northern Indiana. Crop conditions in Iowa and Michigan remained better than conditions in the rest of the District. Crop yields were expected to be highly variable, even within local areas. Corn and soybean prices were restrained because of the carryover from the record harvest in 2004. Farmers continued to face higher operating costs. Fuel surcharges and higher railroad freight rates pushed up transportation costs, and extra pesticide spraying was needed to maintain yields in some areas hurt by the drought.