June 11, 2008 Federal Reserve Districts Eleventh District--Dallas

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Economic expansion in the Eleventh District continued to soften in late April and May, although activity in regions dominated by the energy industry remained robust. Businesses with national sales reported that economic growth in Texas is stronger than in the rest of the country. Retail sales growth continued to be weak, and service sector activity softened. Manufacturing was mixed but improved some. Construction and real estate activity weakened further. Financial service firms reported that loan demand is growing faster than deposits. Agricultural activity improved. Outside the energy industry, record high costs are weighing heavily on profits and leading firms to be less optimistic about the outlook for growth through the end of the year. Prices Higher input prices, including those for energy, are pushing up production costs for most products and services. Rising energy costs put upward price pressure on a wide range of chemicals and plastics. Producers report high or rising prices for most raw materials, including copper, coal, steel, titanium and aluminum. A few producers are stockpiling materials to hedge against higher prices. Food prices continued to rise. These developments are putting upward pressure on selling prices for many products, and some firms are struggling to raise selling prices, increase fees or reduce costs to survive. In the near term, retailers say competitive pressure will remain intense as weaker players go out of business and liquidate inventory. However, retailers say sizable input cost increases are projected and are expected to push up selling prices next year. Selling prices remained soft for most materials used in residential construction because demand is weak and inventories high. Labor Market The labor market remained relatively tight. There are still reports of difficulty hiring and skill shortages, such as for engineers, mechanics and administrative positions. There has been little change in wage pressures, with the notable exception of increases for some truck drivers. However, some firms said they have already experienced or anticipate upward pressure from lower income workers who commute long distances and are being squeezed by high fuel costs. Several industries noted an increase in health insurance costs. Manufacturing Producers of materials used in home construction--such as brick, stone and lumber--reported a slight uptick in activity, but overall demand remained weak and significantly below last year. Inventory levels are high for some products, and those manufacturers are cutting back on production and adjusting workforce levels. While brisk and above year-ago levels, demand for commercial construction materials continued to soften and is expected to steadily weaken. High prices are damping sales for some metals. Fabricated metals producers say smaller construction projects are going forward but big deals that require a significant amount of leverage are not. Domestic steel sales are slowing, but there is strong demand from outside the United States, and producers say it has become more profitable to export than to sell domestically. Overall semiconductor sales have been flat over the past thirty days. Demand from Europe and Asia remained strong, but U.S. sales have been weak. Demand for solar technology is hot, but much of the production is occurring overseas. Semiconductor equipment producers say recent signs of stabilization suggest the worst of the downturn in this cycle may be over. Sales of food products were unchanged, although higher prices have changed the mix of products and customers. Demand for transportation equipment remained strong, with good sales to supply the defense, aircraft and energy industries. Improved margins and an end to the maintenance season have led refiners to ramp up production and capacity utilization. Chemical production has also increased. Weak domestic demand has been partly offset by a surge in exports that has created a shipping logjam. Export demand is strongest for chemicals, such as ethylene, that are domestically produced with natural gas and have a cost advantage over oil-based production in other parts of the world. Retail Sales Gains in retail sales continued to be slower than last year. Retailers said growth has been weaker than they hoped because high fuel costs are limiting discretionary spending. Stores that extend credit reported a deterioration in timely payments. Stimulus checks have increased spending at discount stores. Contacts say shoppers are looking for value, and sales growth is expected to remain weak for several months. Automobile sales weakened slightly and remained below year-ago levels. Inventories have increased for trucks and SUVs but are very low for fuel-efficient vehicles. Services Demand for temporary staffing services was flat over the past six weeks at about the same level as a year ago. Orders were strongest for professional and technical workers in IT, accounting, energy and engineering services. Activity from the manufacturing sector edged up, but demand for entry level financial services and commercial real estate have slowed some. Legal activity continued to be strong, but the mix of work suggests slower economic activity. Real estate transactions declined, but there has been an increase in litigation and bankruptcy work. Oil and gas-related activity also remained brisk. The accounting industry reported moderate sales. Rising fuel costs are straining the transportation industry. Intermodal shipping volumes continued at a level that is softer than earlier this year and a year ago. Exports have increased but not enough to offset the substantial decline in imports. Truckers say diesel prices have become too high to be fully covered by fuel surcharges and, in some instances, drivers have stopped their trucks or are leaving the industry. A few manufacturers said a shortage of truckers has caused delayed shipments and inventory buildup. The rate of contraction in small parcel cargo shipping is slowing. Demand is stronger for leisure air travel than for business. International travel is stronger than domestic. Air fares are rising, and some carriers have reduced capacity in anticipation of reduced travel. Construction and Real Estate Housing activity continued to decline. New and existing home sales fell further, and some builders are abandoning planned developments. Existing home inventories inched up, but remained low enough to keep median home prices from falling by much. Apartment demand was solid, but there is increasing concern about oversupply in Houston and Austin, where construction activity has spiked. Office demand slowed, except in areas dominated by the energy industry, such as Houston and Fort Worth. Industrial demand continued to weaken. Commercial construction levels are still high, but contacts say there are few new projects being initiated because it is difficult to obtain financing, particularly for large investments. Financial Services Partly reflecting reduced credit availability at nonbank lenders, loan demand at banks is growing faster than deposits, and banks have tightened standards to increase interest rate spreads. Community banks reported a strong increase in real estate loan requests because other lenders are no longer funding these borrowers. Overall, past due loans remain low, and there has been no significant decline in credit quality, although respondents expect deterioration. Deposit growth has been weaker than desired, and banks are turning to other sources of liquidity. Contacts reported some improvement in bank funding in recent weeks, with more access to a broader maturity range, but said conditions are not yet normal, and funding is expensive. Respondents indicated that there currently is sufficient liquidity to finance quality deals, but expressed some concern that this may not continue into the future. Energy Optimism about high oil and natural gas prices has pushed drilling to the highest level in 20 years. So far, supplies of equipment and services have been sufficient to keep their price increases at bay. Agriculture Rain improved conditions in most areas, but poor moisture in the Texas High Plains has led to lower projections for wheat yields. Livestock are in good condition. Supplemental feeding continued in drier areas. High fuel and fertilizer costs are leading farmers to plant soybeans instead of corn. Costs are rising, and farmers hope prices will be favorable at harvest time. Producers say market volatility has made it harder to use forward contracts to lock in crop prices. Return to top Kansas City San Francisco