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Federal Reserve Districts

Seventh District--Chicago

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Reports from Seventh District contacts generally suggested that economic activity remained soft in January and February. Consumer spending was again relatively weak, and caution persisted in businesses' capital spending and hiring plans. Strength continued in sales of both new and existing homes, while nonresidential building and real estate activities were again soft. Manufacturing activity remained generally weak but appeared to have improved further from our last report. Bankers continued to report strong mortgage demand from households and weak loan demand from businesses. There were a few new reports of input cost increases, particularly for energy, but prices at the retail level remained largely in check. District farmland values in 2002 posted the largest year-over-year gain since 1997, even as concerns increased about the impact of drought and continued low dairy prices.

Consumer Spending
Overall consumer spending remained weak in January and February. Most retail contacts indicated that sales results in January fell short of their conservative expectations, although one national chain noted some slight improvement in February. Merchants said that sales of food and consumables were stronger than other items, particularly apparel. Inventories generally remained lean as retailers sought to tightly control stocks, although one merchant reported that inventories were rising faster than sales. A contact in casual dining noted that sales had been softening since mid-January, in part because of bad weather and increased fears of terrorism. Auto dealers indicated that light-vehicle sales in the District had slowed from the torrid pace of year-end 2002, particularly in February. Contacts said that light-vehicle inventories were higher than desired, with one noting that "some dealers are getting nervous," given the great deal of uncertainty about sales in coming months. A manufacturer of recreational vehicles said that demand for lower priced units remained strong but that the high end was "suffering." Tourism activities were reported to be flat to down in most areas, and one contact noted fewer attendees at boat and RV shows in the region.

Business Spending
Business spending generally remained weak in January and February. Most contacts suggested that there had been little, if any, change in their actual capital spending or investment plans early in the year. Many expressed uncertainty about the strength of the economy and continued to take a "wait and see" attitude. One computer industry contact indicated that businesses continued to defer both upgrades to mainframe equipment and additions to capacity, which were also adversely affecting software vendors. There were a few reports of stronger advertising activity in January, but it had softened somewhat in February. Business travel remained weak, and there were some reports of firms encouraging workers to postpone or cancel business trips as a result of the increased threat of terrorism. Hiring plans remained very cautious. Reports from temporary staffing firms were mixed but generally indicated that demand remained lackluster. Contacts from many industries suggested that uncertainty about overall economic conditions and the need to contain costs were constraining hiring.

Construction and Real Estate
Construction and real estate activity was again strong on the residential side and soft on the nonresidential side. Sales of both new and existing homes remained strong, according to homebuilders and realtors. Demand for lower priced homes was strongest in most markets, although there were a few reports of improving demand for higher priced new homes in some. One builders association in Wisconsin noted record attendance at their annual home show in January, with builders and remodelers optimistic about the "quality of leads" from the show. Apartment occupancy rates continued to trend down, despite little new development of multifamily rental units. Nonresidential activity remained weak. Office vacancy rates crept up in some markets, in part because of lease termination agreements. While these deals increased official vacancy rates, they also reduced the amount of sublease and "shadow" space on the market. One contact said of office leasing activity, "As for net new demand, we're just not seeing it." Some reports suggested that vacancies rose in some older retail developments and that the number of new retail projects in the pipeline was slowing.

Overall, manufacturing activity remained generally soft but continued to show signs of improvement. Nationwide, light-vehicle sales slowed in January and February but were still tracking at historically strong levels. A contact with one automaker said that the industry expected volatile sales in coming months, and manufacturers were prepared to raise incentives to smooth out sales volumes. This contact also noted that production was down slightly from a year ago, and inventories were a little high. A producer of heavy trucks said that sales had been gradually improving after bottoming in August of last year, and it appeared that "people are buying the new engines" that meet more stringent EPA emissions standards. Production was also holding up, with no plans for additional plant shutdowns. Strong shipments to China were said to be helping buoy steel production, according to one industry contact, but inventories had increased somewhat in recent months. A few producers of machine tools reported that quoting activity (especially for larger projects) was up, and this was translating into some new orders.

Banking and Finance
Overall lending activity continued to reflect the bifurcation in economic activity, with strength on the household side and softness on the business side. Applications for mortgage refinancing may have slowed somewhat, but remained much stronger than most bankers had anticipated. Contacts noted some improvement in household loan quality, as delinquencies and charge-offs decreased modestly. Business lending activity remained very weak. A contact with one large bank said soft business demand was reflected in relatively flat loan volumes, a trend that has persisted over the past six months. Banks that did experience volume increases suggested that the gains were due to market share shifts rather than a general increase in demand. On balance, banks did not appear to be tightening standards on business loans, and there were a few reports that overall business loan quality had improved slightly.

Prices and Employment Costs
There were a few new reports of increasing input costs, but retail price increases remained largely subdued. Of particular concern to many contacts were rising prices of energy and inputs derived from petroleum. One contact said that prices for diesel fuel had risen to "frighteningly high" levels, which could potentially send some small freight carriers into bankruptcy. By contrast, steel prices were said to be stabilizing after some significant increases in 2002. There were no new reports of intensifying pressure on wages, and some companies were said to have delayed merit increases until later in the year. Businesses continued to express concern over rising health and other insurance costs. Despite some increases in input costs, fierce price competition kept most output prices in check. Small-business owners appeared particularly concerned with this trend, as they were finding it increasingly difficult to compete with larger producers on price.

On average, District farmland values at the end of 2002 were up more than 7 percent from a year earlier, the largest year-over-year gain since 1997, according to our survey of rural bankers. Nearly 40 percent of eligible farms in the District had signed up for aid under the Farm Security and Rural Investment Act of 2002, with a crush of applications likely this spring. With drought covering about half the District and another third of the region abnormally dry, there was increasing concern about the growing season. Corn and soybean prices remained higher than a year ago, and contacts suggested prices could rise further, given low stocks and the potential for drought conditions to reduce yields. Higher crop prices had already led food producers to raise some prices. Very low dairy prices and low crop yields last year in parts of Illinois and Indiana contributed to increased financial stress in the District's farm sector.

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Last update: March 5, 2003