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Federal Reserve Districts

Third District - Philadelphia

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Business conditions in the Third District remained soft in November. Manufacturers reported continuing declines in shipments and orders. Retail sales of general merchandise have been improving slowly week by week, but are still below year-ago levels. However, auto sales have been running at a very high rate, boosted by manufacturers' incentive financing. Bank loan volumes have declined in the major credit categories: business, consumer, and real estate. Commercial real estate markets have eased. Home sales rose during October and November, but appear to be off from the same months last year. Firms in a variety of industries in the region have announced layoffs and hiring freezes, but the pace of job cuts does not appear to be accelerating.

The outlook in the Third District business community is generally subdued. Manufacturers predict an upturn by the middle of next year, but in other sectors forecasts are less optimistic. Retailers expect sales for the holiday shopping period this year to be below last year's level, and they are concerned that sales might remain weak into the spring of next year. Auto dealers expect a large drop in sales in the first quarter of next year, as consumer demand ebbs and manufacturers' zero-interest rate financing ends. Bank credit officers expect commercial and industrial lending and consumer credit demand to remain soft, and they expect a drop in real estate lending. Contacts in the real estate industry forecast easing rents and rising vacancy rates in commercial markets and some falloff in the rate of home sales. The general opinion is that the decline in real estate and construction activity will be modest.

Third District manufacturers continued to report decreases in activity in November, with little change in the rate of decline. Orders and shipments were down compared with October in nearly all the major manufacturing sectors in the region, although some firms producing electrical equipment and food products reported increases in orders. A majority of the region's manufacturers maintained steady employment and working hours in November compared with October, although around one-third made cuts, and only a few firms expanded employment or hours. Area firms continued to reduce inventories, on balance, although some firms indicated that inventory reductions have brought stocks down to desired levels. Around one in five firms said they will maintain lower than usual inventory levels because they anticipate a slow recovery in demand for their products. The region's manufacturers generally reported further softening in prices for both inputs and the goods they manufacture, although firms in the food products and electrical equipment sectors have increased prices for their products as demand has picked up.

Local manufacturers have slightly trimmed their forecasts lately. Just over half of the firms surveyed in November forecast increases in orders and shipments during the next six months, but some firms that had previously anticipated a relatively quick upturn now expect business to be flat through most of the first half of next year. On balance, area firms have cut back capital spending plans, but they do not plan to reduce employment from current levels.

Third District retailers reported gradual weekly improvement in sales in October and November, but most indicated that the recent sales pace remains below the rate set in October and November of last year. Discount stores posted moderate year-over-year gains, but sales at department and specialty stores were down. Merchants said shoppers are mainly buying necessary goods and staples. Sales of luxury goods have been especially slow at all types of stores. Some merchants also noted that credit sales have slipped relative to cash sales. Store officials said they are fully stocked for the holiday shopping period, but may trim orders for spring merchandise.

Area retailers expect sales for this year's holiday season to be below last year's. They expect extensive promotions and marketing efforts will be required to make their sales goals, and they are concerned that profits will suffer as a result. Retailers suggested that sales in December and January will be crucial to their plans for the spring. If holiday sales are significantly below current expectations, retailers will cut back orders for merchandise, advertising expenditures, and expansion plans.

Auto sales in the region have been very brisk, in response to manufacturers' zero-interest rate financing. Dealers expect sales to fall off sharply in the first quarter of next year as consumer demand becomes sated and manufacturers' incentive-financing programs end. Dealers have been limiting their orders to manufacturers in anticipation of the drop in sales.

Lending at major Third District banks has been easing. Outstanding loan volume has declined in all major credit categories--commercial, consumer, and real estate. Bank lending officers said demand for business loans has been particularly slow. Some bankers noted that their business customers who have term loans have expressed interest in paying them off ahead of schedule. Several bankers said businesses are reluctant to expand now because economic conditions are uncertain or because they want to wait to take advantage of anticipated tax legislation favorable to capital investment. Concern about business credit quality has grown at banks in the region as a growing number of business borrowers have fallen short of their sales or revenue goals. Nevertheless, most of the bankers contacted for this report said they are still actively seeking to increase their commercial loans.

Bankers in the Third District expect business loan demand to remain soft until there are clear signs that business conditions are improving. They expect demand for new homes to fall, and some are limiting their lending to building contractors. Bankers expect consumer lending to expand slowly as retail sales regain some lost ground.

Real Estate and Construction
Third District commercial real estate markets have eased in the past few months. The vacancy rate for office buildings has risen by one to two percentage points in most market areas in the region. In the Philadelphia central business district, the vacancy rate has risen to around 13 percent, according to recent estimates by commercial real estate firms. In suburban markets, the rate has risen to an average of 14 percent. Vacancy rates have risen as new buildings have come on the market in the suburbs. Also, firms in the Philadelphia central business district and in the suburbs have reduced their use of space, making more space available for sublease. Rental rates have been relatively stable despite softening demand, but commercial real estate agents expect rents to begin trending down throughout the region. Demand for industrial space has also eased. Although the industrial vacancy rate has been steady, many new buildings have become available recently, and real estate agents expect vacancy rates to begin moving up.

Residential real estate agents gave mixed reports. Sales to first-time homebuyers have been resilient, but sales of high-priced homes have eased. Some contacts in the real estate industry also noted a falloff in sales of homes and townhouses in senior citizen communities. Homebuilders reported that sales picked up in October after a sharp drop in September. The higher rate of sales appeared to be persisting in November, but not increasing. Builders have raised prices for homes in most price ranges except the very high end, where demand has eased. Real estate agents and builders indicated that relatively low mortgage interest rates have encouraged first-time homebuyers, and move-up buyers are looking more favorably on house purchases as investments. Real estate agents expect an easing in the sales rate, but not a sharp drop unless employment in the region falls more sharply.

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Last update: November 28, 2001