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Federal Reserve Districts

Eleventh District--Dallas

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Eleventh District economic activity remained generally weak from mid-July to late-August but there is improved optimism about the outlook for activity. There was little change in manufacturing or service sector activity, but retail sales were higher. Contacts at financial institutions reported slightly improved conditions. Construction and real estate markets were also very slightly improved. There was little change in energy activity, and dry weather hampered agricultural production.

Higher energy costs were reported as a concern, particularly by manufacturers, and these increased costs are being passed along to consumers when possible. Crude oil prices moved in a narrow range of $30-$32 for West Texas Intermediate during the period. U.S. crude inventories are only slightly higher than the 27-year low set during the disruption of Venezuelan crude deliveries earlier this year. Retail gasoline prices nationally rose from $1.53 to $1.58 between late June and early August. The blackout is expected to briefly add another 10 cents to gasoline prices. Gasoline inventories remained at the lowest levels of the last 8 months.

Natural gas prices fell steadily throughout the period as storage continued to fill at a faster than normal pace, but prices remain high compared to this time last year. Spot prices fell to $4.60 in late July, a decline of 60 percent since February. Natural gas in storage is now only 9.4 percent below the 5-year average, and 18 percent below last year. Storage was 35 percent below the five-year average earlier this year. Natural gas going into storage this summer does not appear to be coming from new supplies, rather it is the result of "demand destruction"-large industrial users closing, cutting back or switching to oil.

Prices continue to fall for most manufactured products, including apparel, lumber and paper. Paper producers say that consolidation in the industry is keeping prices 10 percent to 15 percent higher than demand would dictate, and future price declines are anticipated. Prices for fabricated metals are being heavily discounted (or the quality of the product improved) to keep up with the competitiveness of the industry, despite rising input prices.

Manufacturers continued to report tough economic conditions, with lower than expected demand and continued layoffs at some plants. Still there were some reports of increased activity and many contacts were more optimistic-or less pessimistic-than they were six weeks ago. The pace of layoffs appears to be slowing.

Paper producers say that demand remains soft even though this should be a time of seasonally increasing activity. Contacts attribute the weakness to a lack of manufacturing activity, and say that the pick up in demand for boxes to ship Christmas orders was smaller than is typical. Some paper companies have reduced their workforce to cut costs, eliminating support positions rather than production workers. Others firms anticipate some future layoffs if business does not pick up.

Construction-related manufacturers reported a slight increase in demand but expressed concern that, without a backlog of orders, the outlook for activity is uncertain. Demand for fabricated metals and lumber picked up. The increase in lumber sales was partially seasonal, and contacts say that sales are just "less horrible" than they have been in the past. Demand for brick and cement was unchanged, but competitive pressures remain stiff. Companies say they are still finishing up projects stimulated by lower interest rates, and indicated some worries that rising mortgage rates could dampen demand down the road.

Demand for primary metals has been "spotty" over the past month. Contacts say the industry is experiencing stronger demand than a year ago and quoting activity has increased. Demand for apparel products is picking up, but manufacturers continue to lay off workers to remain competitive. There was little change in demand for food products.

Orders of high-tech products continued to increase, although at a slower pace than the strong second quarter. Steady gains in personal computer and cell phone sales since the last survey continued to drive the demand for semiconductors. Asia was reported to be a hotbed for semiconductor production and consumption while demand in the U.S. was described as "better but not robust." Much of the demand for PCs continues to come from consumers, but replacement demand by businesses continues to improve. One respondent noted that there is still little hiring because companies are improving profits by driving up productivity as far as they can. Most respondents expect continued improvement for the remainder of the year.

Demand for chemicals remains weak and prices have fallen again for ethylene, propylene, styrene, polyethylene, polypropylene, and polyvinyl chloride. Demand has been sluggish domestically, and export markets are hurt by the high price of natural gas relative to oil.

A series of accidents and unplanned outages at refineries caused several spikes in the price of gasoline in July, and tightened supply enough to move spot prices over $1.10 per gallon in late August. Additional refinery outages as a result of the blackout further reduced production and impaired pipelines. Gasoline consumption for the first half of 2003 was down compared to a year ago, the first six-month decline since the 1990-91 recession. Capacity utilization on the Texas and Louisiana Gulf Coast rose slightly from 95 to 96 percent. Refiner's margins improved throughout the period, mainly on the basis of higher gasoline prices.

There was increased optimism in the service sector, although activity was mostly unchanged. Demand is mostly unchanged for temporary staffing and placement, although there was a pick up in staffing needs for tech support and call centers. Legal contacts also reported little change in overall activity. There has been some drop-off in regulatory work, but activity is steady for litigation and bankruptcy. There is still little demand for mergers and acquisitions, and this comes as somewhat of a surprise as contacts anticipated a reaction to pent-up demand by now. Legal work to support transactions has picked up a little and clients are beginning to plan more for the future.

With the exception of higher than expected fuel prices, airlines continue to report steady improvement. Overall, airplanes are carrying more passengers and prices are moving up. As long as industry capacity stays where it is, the outlook has improved in the medium term. The outlook for trucking is "looking a little better." Rail shipments in the Western U.S. are still running slightly higher than year-ago levels. Future months could see some upward pressure on prices if rail capacity is tested with rising demand.

Retail Sales
Retail sales growth increased over the past six weeks, and retailers are cautiously optimistic that sales will continue to meet the high end of expectations. While there was some question about how much the sales pickup was stimulated by tax refund checks, retailers who cashed checks in the stores believe the increased sales are not entirely induced by tax credits. Competition remains stiff, and retailers say they still have no pricing power. Because prices have fallen for most products, contacts note that the volume of sales has increased by more than the dollar growth of sales suggests. There has been no change in the pace of automobile sales. Respondents expect steady business ahead, but not to the peak-levels experienced in the last couple years.

Financial Services
Financial conditions have improved slightly leading contacts to be more optimistic about the outlook for activity, although caution remains. Business is returning, according to respondents, who say that traffic and referrals are up, and customers appear to be expressing more interest in capital investment and doing deals, but are not yet ready to pull the trigger. Deposit growth remains strong and loan demand appears to be stable to up in most categories. Mortgage activity is still the strongest category with consumer lending close behind. The recent increase in mortgage rates has spurred people to act before rates increase further, according to contacts. Auto lending remains weak with strong competition between banks, credit unions and "captive" lenders, such as GMAC or Ford Credit. Commercial and industrial lending is mildly positive but caution is still prevalent.

Construction and Real Estate
Construction and real estate markets improved some over the past six weeks. Contacts say the up-tick in mortgage rates pushed some fence-sitters into the new and existing-home markets. The industry remains very competitive, restraining price increases. New home construction rose in some metro areas, but contacts believe building will ease in the latter part of the year. The strong housing market has come at the expense of the apartment market, which continues to experience growing supply and reduced demand.

Contacts are more optimistic about commercial real estate markets. A recent pick up in leasing inquiries seems to have ended the deterioration in the office market. With little office construction underway, contacts are hoping for improvement later in the year, although it is unlikely that a noticeable turnaround will occur until 2004. Retail markets remain the best performing of the commercial sectors. Demand for industrial space was up in Houston and flat to down in Dallas.

After growing strongly in the early part of the year, District drilling activity leveled off in mid-May and has remained relatively constant. Drilling in the Gulf of Mexico remains unchanged, although some rigs moving to Mexico may improve utilization and day rates. The U.S. domestic rig count leveled off in recent weeks before dropping sharply at the latest weekly reading. The decline raised concerns that domestic activity is peaking, but the drop was related more to wet weather than to market fundamentals. International drilling remains strong. Respondents continue to describe the current market as very good if not great, and to be moderately optimistic about the future. Pricing is adequate for capital recovery, but companies are controlling costs and remain cautious about hiring. Despite slower growth in domestic activity, service companies continue to report a good market, with adequate margins and pricing that continues to slowly improve.

Hot, dry conditions reduced soil moisture and stressed some crops. The cotton crop, especially dryland cotton, has suffered damage because of the heat, and yields are expected to be below year-earlier levels. Hot weather has also affected the corn crop. Crop production continues to be hampered by high energy costs and relatively low commodity prices. The cattle market remains in relatively good shape with steady demand and stable prices, but some contacts said water supplies were getting low, and range conditions were deteriorating quickly in the heat. Supplemental feeding of cattle continues in the driest areas.

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Last update: September 3, 2003