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Federal Reserve Districts

Eleventh District--Dallas

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Overall Eleventh District economic activity strengthened in January and February. Energy activity remains extremely strong. Reports from the manufacturing, construction and service sectors also strengthened. Consumer spending was mixed. Retailers said sales growth was up in January but declined in February, and auto sales were down. The financial services industry reported some softening in consumer lending.Agricultural conditions remain extremely dry.

Contacts in both the construction and manufacturing sector are keeping their eyes on the housing market with optimistic trepidation. At this point there is little evidence that slowing in other housing markets has spread to this region.

High energy costs remain a concern for many industries. Crude oil prices fluctuated between $58 and $68 per barrel over the past two months. Crude demand has remained relatively weak, with refinery capacity utilization low and imports of refined products at record levels.

Wholesale gasoline prices are down, falling from $1.85 in early January to $1.50 in early March. Retail gasoline prices have fallen by about 10 cents during the same period. Gasoline demand has been strong, but inventories were built up dramatically through record imports and the return of most the hurricane damaged refining capacity. Contacts expect upward pressure on gasoline prices for several reasons. The refinery maintenance season is just beginning, price incentives to ship gasoline from Europe to the U.S. have disappeared, and new environmental restrictions on additives and sulfur will eliminate many imports over the summer. Heating oil prices have fallen from $1.75 to $1.65. Diesel and heating oil inventories have built up thanks to a very warm winter.

Natural gas prices have fallen from near $9 per thousand cubic feet in early January to below $7. Natural gas inventories are currently 48 percent above the five-year average level and are expected to be at record high levels for the season going into the spring and summer.

Manufacturers report that high energy and other input costs are putting upward pressure on selling prices, but competition is limiting some price increases. Prices are up for primary metals, stone, clay, brick and glass. Paper producers announced a spring price increase, but many in the industry do not expect it to stick. Steel prices have been declining, according to contacts, who say that imports of less expensive steel are squeezing profits. Selling prices have declined for petrochemicals, such as ethylene, polyethylene, polypropylene, PVC and chlorine, but prices remain well above pre-hurricane levels. The service sector reports that utility costs are pushing up rents and transportation costs.

Texas home prices have increased at a faster pace in recent months, according to contacts, who say the increase is driven by economic fundamentals rather than speculation. The construction industry expressed growing concern about rising costs for energy, lumber and other inputs. Cement prices have eased some, because a reduction in tariffs has increased imports from Mexico.

Labor Market
The labor market continues to firm. Hiring was reported at both manufacturing and service companies. While there are little or no wage pressures in some industries, others report growing pressure. Salaries continue to increase at accounting firms, and temporary service firms said wages are rising for lower paid workers. Many contacts expressed serious concern about the high and rapidly rising cost of health insurance, even in industries without wage pressures.

Shortages of some types of skilled employees remain a concern, and worker shortages are constraining activity in the construction and energy industries, according to contacts. A shortage of skilled oilfield workers is expected to push up labor costs in that industry by 10 percent or more this year.

Manufacturing activity picked up. Demand remained strong for energy and construction-related products. The high-tech sector continued to strengthen. Demand for apparel and food products was up, but sales of paper were seasonally slower.

Demand remained strong for stone, clay, brick and glass, boosted by sales for construction and oil and gas drilling. Lower tariffs on cement imports from Mexico are helping ease but not eliminate shortages, according to contacts. Good weather spurred demand for lumber and reduced inventories, but firms say they will see if good weather persists before rebuilding inventory. Metals producers reported little change in demand. Some expressed concern that there had been some sales weakness as a result of construction slowing in other parts of the country, but most contacts see no substantive evidence of slowing and do not expect it.

Manufacturers of high-tech equipment said that production and orders growth continued at a healthy pace since the last survey. Demand continued strong for flash memory for hand-held music devices and multi-function communication devices. Inventories are lean.

A narrowing spread between product and crude prices led some refineries to briefly reduce production in February. Operating rates on the Gulf Coast and at the national level are declining, as the industry begins the spring turnaround season. Maintenance turnarounds are expected to be longer than normal because work had to be postponed because of the hurricanes last fall. Petrochemical production along the Gulf has returned to normal levels. Contacts expect a pick up in domestic demand in the weeks ahead as seasonal weakness passes and spring construction picks up.

Temporary staffing agencies say activity picked up and was markedly higher than expected. Orders were primarily to supply workers for call centers, distribution centers and light industrial manufacturing. Accounting firms reported strong activity and increased hiring mostly due to Sarbanes-Oxley and seasonal tax needs. Demand for legal services remained strong, especially for litigation, transactions, real estate and corporate activity. Some contacts noted that out-of-state investors were helping drive real estate transactions.

Demand for transportation services remained strong. Trucking firms say demand is still solid, and a shortage of qualified drivers is limiting their capacity to take on more business. Cargo volume increased at a slower pace over the past six weeks--mostly due to post-holiday inventory liquidations. Increase in volume came from growth in shipments of durable goods. Contacts say continuing high demand for trade services has pushed up shipping rates at a faster pace than cost increases.

Rail activity remained strong, with increases in shipments of crushed stone, metals, grain and coal. Shipments of construction-related materials, wood, metallic ores and motor vehicles declined. Contacts say the industry is operating at or near capacity, and expansion plans are underway. Demand for air travel has also been strong, and carriers say load factors are high. While fuel costs remain a concern, reduced capacity and increased prices have helped improve the outlook.

Retail Sales
Gift card redemptions and clearance sales helped spur strong sales growth in January. February sales growth was softer. Retailers are uncertain about the strength of consumer spending and say Easter's shift from March in 2005 to April in 2006 will make it difficult to evaluate for a few months. Still, contacts are cautiously optimistic about the outlook. Auto sales have been unusually slow, according to dealers. Contacts speculate that the market has become saturated by a long stream of rebate offers. Inventory levels are high. Some dealers have reduced salaries.

Construction and Real Estate
Demand for new and existing homes continued to be strong since early January. Existing homes sales are still rising in Austin and Houston, but there was some weakening in the Dallas/Fort Worth area. Builders report that new home demand in Texas did not follow the trend in other states, where they experienced slower sales and higher contract defaults. They expressed growing caution about the outlook, however, voicing concerns about talk of a "nationwide" downturn in the housing market, labor shortages due to hurricane rebuilding, and escalating materials costs.

Apartment demand has been strong. Unusually warm weather may have helped boost leasing activity, according to contacts, who say this is normally a slow time of year. Multifamily construction starts increased recently, with many of the projects expected to continue into 2007. Respondents say the construction is mostly justified, because vacancy rates are tight for newer "top-tier" properties but expressed some caution that rents would increase enough to justify future projects.

Office leasing continued to increase at a steady pace, and rents are up in some areas. Demand and selling prices were up for industrial properties, boosted by sales to out-of-state investors.

Financial Services
Consumer lending softened. Contacts report slowing in automobile loans and residential mortgages, especially for hybrid adjustable rate mortgages. Contacts say yields are higher on auto loans, fixed rate mortgages and home equity lines of credit. Loan quality remains good, however, and deposit growth unchanged. There were reports of fierce pricing competition for commercial loans.

The U.S. rig count has reached a 20-year high, rising by roughly 75 rigs since early January. The increase in activity is primarily the addition of newly-constructed rigs but is also due to the arrival of some foreign rigs and some hurricane-damaged rigs returning to service. An additional 250 rigs are under construction, although shortages of component parts, such as mud pumps and engines, are causing some delays. Manufacturers of energy equipment report long and growing backlogs of orders.

Oil service activity remains strong and driven mostly by land-based drilling directed toward natural gas. Service costs are still rising, pushed up by increasing labor costs, rig rental rates and the cost of pressure pumping for fracturing formations. International activity also continues to rise, with recent gains stemming from Latin America, the United Kingdom, and Saudi Arabia.

Low water supplies, poor pasture conditions and high feed prices are encouraging cow-calf producers to limit herd expansion. Most farmers continue to await rainfall for sufficient moisture to prepare land for planting. Contacts in the banking industry say they may not be able to finance some farm operations, especially those without irrigation, unless sufficient rain restores soil moisture. Producers are extremely concerned about high energy, fertilizer and chemical costs. The high cost has limited purchase and forward bookings of inputs and has tempered income gains in the agribusiness industry. Contacts are hopeful that 2006 farm program payments may provide some relief to producers and expressed concern that the structure of the farm program could be shifted from subsidy payments for specific commodities to investment in rural development.

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Last update: March 15, 2006