April 21, 2004 Federal Reserve Districts Eleventh District--Dallas

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Eleventh District economic activity continued to accelerate from mid-February to mid-April. Retail sales growth was surprisingly strong, according to contacts, but there has been little change in demand for business services. Manufacturing respondents report that they are experiencing stronger sales that are partly the result of growing demand and partly the result of previous reductions in industry capacity. Construction and real estate activity is showing scattered signs of picking up. Residential activity remains quite strong but is softening. Contacts expressed concern that there will need to be a pickup in relocations or job growth for residential activity to remain strong and for nonresidential activity to strengthen. Agricultural conditions are favorable. In general, contacts are optimistic about the outlook for activity, but remain cautious, noting concerns that the upcoming presidential election will likely result in a lot of negative press about the economy that could dampen activity. Prices Contacts report rising input costs in many industries, particularly manufacturing, with notably sharp increases for fuel, shipping, aluminum, natural gas, coke, coal, metals and food products. The lower value of the dollar was pushing up input costs for some companies. Some cost increases are working their way through to selling prices. Contacts say they are absorbing a lot of the cost and are still finding ways to increase productivity to lower production costs. Even so, contacts say they will have to pass more along to the consumer very soon, and many expect to be able to do so. Producers of cement, glass, tile and brick reported improved ability to pass cost increases forward to their customers. Lumber and paper producers also reported higher input and selling prices, and paper producers expect further gains in selling prices in the third quarter. Fabricated metals producers say heavy demand from China has drawn down their suppliers' inventories and led to shortages of several inputs, such as galvanized metal and steel. The removal of steel tariffs has not done much to alleviate price increases, they say, because supply lines that were directed away from the U.S. when the tariffs were in place have yet to be redirected back, leaving the industry dependent on domestic suppliers of steel. Strong U.S. demand for gasoline lowered inventories and pushed up retail prices to record highs (in nominal dollars). Oil prices have been boosted by strong global demand (especially in Asia), threats of terror attacks, a lower dollar, low inventories, and the announcement of OPEC production cuts. Crude inventories have risen five of the last six weeks, and are now just above the lower range of five-year averages. Heating oil prices declined seasonally throughout the period from 94 to 84 cents per gallon. Natural gas prices remain high despite inventories that are only slightly below normal for this time of year, pushed up by rising oil prices and expectations that future sources of natural gas will be more expensive. Petrochemical price increases are being seen in a long list of base chemicals and plastics, including ethylene, propylene, polypropylene, styrene, polystyrene, polyvinyl chloride, and PET bottle plastic. Capacity shortages are reported for ethylene, chlorine, styrene, but styrene pricing may fall back some as the turnaround season ends, and ethylene will soon face increased supply from a new facility that is just starting up. Restaurant prices are up 1 to 2 percent. Legal fees are up 5 to 10 percent. Railroads continue to operate at or near capacity. Strengthening demand has enabled firms to raise prices and pass higher fuel costs on to customers. Trucking firms plan to increase prices to pass higher fuel costs on to clients. Retailers say they are beginning to have some pricing authority. Input prices are higher for many products, largely because of the weaker dollar. Still contacts say they find ways to redesign products to lower the cost of production. Contacts also said that, in response to the antidumping concerns with Chinese products, they have been able to find furniture production in other countries at a similar quality and production cost. Retail inventories are in good shape, but retailers commented that they have remained conservative in their purchases for the rest of the year, preferring to be surprised by stronger demand that will allow pricing power rather than being left with excess inventory. Some high-tech manufacturers reported significant price pressures, and bookings four months out suggest some moderate price increases. Telecommunication equipment prices remain low due mostly to an increasingly competitive market. Selling prices are also lower for apparel producers, and they see no signs of upward pressure in the future. Airline passengers remain price sensitive and firms continue to offer discounts to stimulate demand. Industry capacity is outstripping GDP growth, and surging fuel prices are keeping profit margins slim. Carriers are having difficulty in pushing fuel surcharges through. Competition for new homes has put a lid on price increases despite higher steel and lumber costs. Labor Market Hiring is picking up for some types of workers, such as for production workers in high tech, apparel and lumber manufacturing. There is still a large pool of unskilled laborers seeking employment, according to contacts. Some companies in both services and manufacturing are continuing to outsource both domestically and internationally. Overall there continues to be very little pressure on wages, but most contacts reported continued health care pressures. Some respondents have suggested that this has been a main impediment to hiring full time workers. There has been a growing trend in some of these increases in health costs being passed along to the employee. One contact noted that, as a consequence, some workers had reduced or declined coverage and that there had been a sharp rise in workers' compensation claims and costs. Manufacturing Demand is up for apparel, food products, lumber and paper. Paper producers credit an increase in orders for packaging from retailers and the closing down of some competitors. Demand for some construction-related materials, such as cement, glass, tile and brick, was up markedly from January and up moderately from March 2003. One contact reported importing cement to meet demand within the District. Demand for primary metals is stronger than a year ago but has slowed some in recent weeks. Producers of fabricated metals say there has been little change in demand. High-tech manufacturers report that growth in orders has increased slightly since the last survey. One contact said that growth is coming from increased demand for existing products and that, with the exception of high-definition TV and wireless communication, most manufacturers have not increased their research and development into new products. Telecommunications manufacturers have seen slow improvement in the last few months. Telecommunications service providers have seen a slight improvement in business spending, which is usually a promising signal of an improving market. Demand for petrochemicals has been strong and the industry continues to improve, with only a few areas having a serious overcapacity problem, such as polystyrene. The overcapacity has been cured in some areas like chlorine and ethylene by a slump that lasted long enough to permanently close some plants. Competition from imports has been limited by a weak dollar and heavy demand from China. Strong demand for gasoline has boosted profit margins for refineries. Capacity utilization has been a little low, in part because of seasonal maintenance that is now ending. Inventories of gasoline are at a five-year low for this time of year. Services Legal contacts say activity continues at roughly the same pace. There has been a sporadic increase in merger and acquisition activity and a drop in work to support bankruptcies. Transportation activity is mixed. Rail demand is strong across a range of categories and shipments are up significantly over last year. Contacts plan to hire additional employees and increase the size of their locomotive fleet. Demand for air travel is also up over the past month. Trucking activity is still soft, but contacts are optimistic that demand will improve. Retail Sales Most retailers reported surprisingly strong sales growth--even after adjusting for Easter sales occurring earlier this year than last year. In general, sales at higher end stores were better than of discount stores. Contacts say that consumers are happy and are showing "classic signs" that they have money to spend. Still many retailers are remaining cautious, planning their inventories for weaker sales than they hope materializes. Slow sales of automobiles continue to push down prices and cut into profit margins, according to dealers. Inventories at most dealers remain high. Construction and Real Estate New home sales continue to rise at a good pace but are very competitive. Contacts say that demand is being driven by low mortgage interest rates rather than a pickup in employment growth or relocations. Some builders are reducing their inventory of homes because of less-than-predicted relocations. Existing home sales remain strong as well, but continued increases in home inventories have kept a damper on prices. Apartment leasing picked up in Dallas and Houston over the past six weeks, according to respondents. Concessions are still rampant, particularly in Dallas, and effective rents continued to decline, but at a slower pace. Contacts are concerned about the amount of apartment construction and fear it may slow the sector's recovery. Texas' largest office markets were mostly unchanged over the past six weeks. The amount of space available edged up slightly in Dallas, and rents fell, although the rate of decline has slowed compared with last year. Despite the large amount of space available, Dallas remains a hotbed of investor activity, according to respondents. Houston's weak downtown market is still dealing with repercussions related to the fallout in energy trading. Contacts say a recent announcement to relocate 2,000 employees into downtown is a promising sign. Financial Services Lending continues to pick up, particularly for commercial and industrial projects. Consumer lending is also reported to be stronger than earlier this year or last year. Contacts say that activity is improving but not yet robust. Deposit growth is flat, which respondents attribute to money flowing back into financial markets. Continued competition, especially in the Dallas and Houston markets, remains fierce keeping rates down and fees/fee structures under pressure. Recent announcements by out of state banks to enter these markets and aggressive expansion by banks already in these markets are putting downward pressure on rates and fees. Energy Onshore drilling continues to respond to higher energy prices. Drilling activity is mostly simple, low risk, low cost rigs that add little to the demand for services, however. Although some respondents made hopeful statements that some areas of the oil service business might tighten soon, there remains considerable excess capacity in all lines of business. Offshore drilling in the U.S. continues to decline, and there is no indication it will pick up soon. Oil producers continue to claim there are no good prospects left in the region. International drilling remains strong. Only the largest companies are active in this part of the industry. Agriculture Farmers continue to prepare land for planting. Contacts report that the outbreak of the avian influenza reported in early 2004 in Gonzalez County has been officially declared eradicated, benefiting poultry producers in the District. Demand for beef strengthened and prices edged up. Mexico opened its markets to beef from the U.S., and contacts report shipping beef in large numbers. No new cases of BSE have been found. Return to top Kansas City San Francisco