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Federal Reserve Districts

Eleventh District--Dallas

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The pace of economic activity in the Eleventh District continued to decelerate in July and August, but respondents with national operations said the District economy remained stronger than much of the rest of the country. Tighter credit standards curtailed some residential construction, which caused home building to decelerate at a slightly faster pace. The level of nonresidential construction is still high, but tighter credit standards have restrained some commercial investment. Manufacturing activity picked up slightly in recent weeks. Demand for business services was mixed, but overall activity was similar to the last report. Retail sales continued at roughly the same pace, but auto sales were softer. Energy activity remains robust, and agricultural conditions were mostly positive.

Contacts within the lending and real estate communities are highly focused on recent changes in the perception of credit risk and most have taken steps to cut costs and/or reduce employment. A few companies reported serious financial stress. Others remain optimistic that, while the cost of funds has increased for some borrowers, markets will settle within 60 to 90 days leaving little long-lasting effect.

Outside the lending and real estate communities, contacts are much less focused on or concerned about recent changes in credit markets. A few expressed relief that the adjustment has finally occurred and conditions are not worse. While cautious, many firms reported seeing no impact so far for their customers or their company. Retailers who lend to customers said they have experienced an increase in delinquencies that has led them to become more careful scrutinizing the credit worthiness of customers. A few are looking forward to lower costs for commercial real estate. While many business leaders expressed increased nervousness about the outlook, most were optimistic that there would be no material impact on their firm and had not changed their business plan.

Energy costs remained high, and fuel surcharges are commonplace. Strong demand for corn for ethanol has resulted in higher costs for many food items, and contacts say these costs are being passed to selling prices. Strong demand led to price increases for most chemicals, and increased feedstock costs pushed up plastic prices. Declines in the value of the dollar have raised import costs for several industries. High input costs are resulting in double-digit price increases for paper products. High-tech manufacturers report upward pressure on some prices, such as flash memory and flat panel glass. Airfares are higher.

There is downward pressure on real estate prices. Upward price pressures have abated for many construction-related products; steel prices are steady at high levels, and prices have fallen for lumber, aluminum and copper. Retailers say discounts are pushing down selling prices. Auto dealers have increased incentives for both domestic and imported models. High-tech firms say overcapacity is pushing down DRAM prices. Natural gas prices have fallen, and the energy industry reported less upward price pressure for some items used in drilling. Wholesale gasoline prices fell as growing capacity utilization by refineries pushed domestic inventories back up to the bottom of the normal range for this time of year.

Labor Market
The labor market remained tight, particularly for skilled workers. Wages are rising substantially for some positions, such as lawyers. The current adjustment in homebuilding and financial services had led to layoffs and hiring freezes in those industries. A few contacts said workers with financial experience are in hot demand, and some who have lost their jobs are being actively solicited by other firms. A number of industries continued to report difficulty finding workers. Some firms expressed concern that the already tight labor market will tighten further because of stricter enforcement of immigration laws, including the recently implemented no-match program that requires closer scrutiny of some workers' social security numbers.

Factory production continued to slow for products supplying residential construction, such as brick, lumber, cement and primary metals. Most producers expect further deterioration in sales, except in the lumber industry where contacts believe the current slow level will persist but not worsen. Demand remained solid to supply products related to nonresidential construction, such as for schools, infrastructure and commercial projects. Fabricated metals producers reported a pickup in activity, as crews returned to work following rain disruptions earlier this summer.

Demand for paper products was mixed. Firms supplying cleaning supplies and other paper products to offices reported strong increases in demand and an optimistic outlook. Sales of corrugated boxes to manufacturers continued to soften, and the outlook was more uncertain.

Producers of high tech products said sales and orders continued to grow at about the same or a slightly faster pace. Equipment manufacturers reported a slow down in orders that they expect will continue through the end of the year.

Food producers said demand was solid, although contacts are wary about a possible slowdown as price increases are passed to consumers. Factories producing transportation parts and vehicles reported continued solid or strong activity, with the exception of automobiles, where weaker demand led at least one factory to reduce production.

Refineries moved back over 90 percent utilization rates. Petrochemical sales were strong, boosted by a weak dollar and buoyant global demand. Sales of most plastics have been climbing steadily for most of this year. Weakness in the housing market has hurt sales of PVC pipe and siding.

Temporary staffing firms said demand improved slightly, with a pickup for call centers, manufacturing and energy. Orders were strong for workers with accounting and IT skills, mixed for financial services and soft for construction. Accounting activity was steady and strong--up a bit from last year. Demand in the energy, audit and tax sectors was solid. Law firms say activity is unchanged and slightly below last year. One contact said "credit issues" dampened transactional work.

Rail, small parcel, and intermodal transportation firms reported small decreases in cargo volume over the past month. Airlines say loads and bookings are stronger than expected, and there is no sign that consumer or business travelers are slowing down.

Retail Sales
Retailers reported little change in the growth of consumer spending in July and August but noted that a number of factors are making it difficult to interpret trends, including a shift in the start of back-to-school and stocking up that occurred in anticipation of a hurricane. Sales continued to be below the level of a year ago but were stronger than in the country as a whole. Purchasing patterns and payment histories suggest customers are under more financial stress than earlier this summer. Most firms have become more nervous about the outlook but have not changed their plans. Automobile sales have been soft over the past six weeks--down significantly from a year ago for both car and service sales. Contacts expressed nervousness because, they say, the automotive market tends to follow the mortgage market.

Construction and Real Estate
Residential real estate markets showed more signs of weakness in July and August. Home sales continued to soften due to lower demand, tighter credit standards and buyers having difficulty selling their current houses. New home cancellations are still high. Contacts said credit standards were tightened for lower-priced homes two to three months ago, and now buyers of homes above $500,000 are having problems obtaining financing. Inventories are rising, leading a few respondents to express concern about potential weakness in home prices. The outlook is mixed; many contacts expect the lending adjustment to be short-lived, resulting in a sales rebound in 2008. Others-- particularly builders--are more pessimistic, projecting a rebound in 2009.

Office leasing activity remained slower than last year, but market fundamentals are relatively good, with positive absorption and rising rents. Developers say financing terms are changing mid-deal, with lenders appearing unsure of how to price loans. According to some respondents, there are fewer investors seeking property, and some investment and/or development deals have been canceled. Contacts are nervous but think the situation will correct itself soon. However, they fear investor confidence will erode if problems continue into September.

Financial Services
Banks and credit unions reported a pick up in deposit growth and good credit quality. Consumer lending softened earlier this year and further deterioration is not expected. The financial services industry has become more cautious about lending and has tightened credit standards while they're evaluating risk management. Uncertainty about how to measure and assess risk has led to changes in the structure, leverage and pricing of loans. Contacts expect these changes to continue over the next several weeks until the market stabilizes. With the exception of homebuilders, they say their clients' businesses look good and economic fundamentals remained strong.

Energy activity remained robust. Domestic drilling has flattened out in recent months, causing a sharp slowdown in demand for durable equipment, such as drill pipe and rigs. Day rates for land rigs are flat to down slightly. Demand is still strong for services delivered at the wellhead or for machinery and supplies consumed during the drilling process. Pricing remained very profitable, but the flat market has seen some "some push-back" by producers and "sharper negotiations." International drilling is growing and remained the primary source of strength for service companies.

Contacts expressed concern that the growing inventory of natural gas may push prices down to levels that will restrain some activity. Unconventional natural gas has been an important element of the current level of drilling, and high natural gas prices are required to justify this drilling. There are no signs of a slowdown so far, and pressure pumping--a service closely associated with unconventional drilling--was described as improving in demand and pricing in recent months.

Soil moisture was adequate in most areas, boosting pasture growth and livestock conditions. Cotton acreage was maturing well, and harvest was in full swing in several parts of the District. Strong summer rains temporarily halted field activities and deteriorated crop conditions in some areas. The grain sorghum crop took the brunt of wet weather, resulting in both yield and quality losses.

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Last update: September 5, 2007