October 15, 2003 Federal Reserve Districts Seventh District--Chicago

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Seventh District economic activity continued to show signs of modest improvement in late August and September. However, many businesses wanted to see a longer period of firming in demand before committing to hiring, expanding capacity, or inventory building. Consumer spending was stronger than earlier in the year, but sales results were mixed by retail segment. Business attitudes appeared to improve further, yet spending and hiring plans remained cautious. Construction and real estate activities continued to be characterized by strong residential markets and weak commercial markets. Manufacturing activity continued to expand. Bank lending remained relatively soft. There were only small changes in the price and cost environments. Early harvest results suggest that corn output will be at least average, but that soybean output will be well below average. Consumer spending Consumer spending in August and September still appeared to be stronger than earlier in the year, although reports were mixed. Retailers said that sales generally exceeded expectations, as consumers continued to purchase deeply discounted merchandise. Inventories were leaner than expected as a result. Still, most merchants were not confident enough about sales prospects to boost inventories in the near term. While apparel sales generally remained sluggish, there was a sharp rise in sales of baseball-related apparel in the Chicago area. By contrast, a contact in casual dining indicated that food service sales remained soft. District auto dealers said that light vehicle sales fell from August to September, and seemed softer than the national trend in both months. With weaker sales, dealers continued to curb light vehicle orders and draw down inventories. Many dealers also noted that service sales slowed in September after picking up toward the end of summer. Business spending Business attitudes continued to improve, although spending and hiring plans remained cautious. Several contacts noted that businesses were seeing better earnings, but much of the improvement resulted from cost containment rather than revenue gains. One contact suggested that firms want to see several periods of stronger revenue growth "in their rearview mirrors" before they commit to capacity expansion and permanent hiring. Most capital equipment spending continued to go toward the maintenance, repair, or replacement of existing stock. On the hiring side, contacts with temporary help firms reported a seasonal pickup in worker orders; for one national firm, this was the first seasonal boost in three years. The jump in worker assignments was particularly evident in the light industrial and office/clerical categories. Several contacts suggested that the bulk of new temporary hiring was done by small employers rather than large. Still, most businesses remained very reluctant to add permanent full-time help, although there were a few reports of increasing worker hours. Construction and Real Estate As has been true for some time now, District real estate markets were strong on the residential side and weak on the commercial side. New home sales were again robust, with one contact's comment that "business is great" generally summing up builders' sentiment. Sales of first-time-buyer and trade-up homes continued to drive the market, although there were a few reports of a pickup in the luxury segment. Traffic through builders' annual "Fall Parade of Homes" was very high in most areas, leaving builders more optimistic that new home sales will remain strong well into the fall. Existing home sales were also very strong in most parts of the District. Commercial activities appeared to slow somewhat. Some contacts said that the number of office property tours and prospects fell recently, after picking up through the summer. On balance, office vacancy rates were flat in the third quarter, and rents remained under downward pressure. Light industrial vacancies remained elevated and there were some concerns that big-box retail space was overdeveloped. Manufacturing Manufacturing activity continued to expand in late August and September. Nationally, light vehicle demand exceeded some automakers' expectations over the summer months, which helped bring inventories down to desired levels sooner than anticipated. Despite stronger sales, automakers did not report any changes to production schedules. A leading producer of home appliances said that shipments picked up in recent months as distributors replenished depleted inventories. Some heavy equipment industries were seeing a "pretty good recovery," according to one contact, and even though inventories were rising, the inventory-to-sales ratio continued to decline. Medium-duty truck dealers were also said to be rebuilding inventories, helping to boost shipments in September. Some producers of machine tools noted increases in price quotes, new orders, and shipments. Moreover, one contact suggested that the increase in demand for machine tools was coming from customers across a wider range of industries. Despite little change in demand, domestic steel production improved modestly as imports continued to fall. Banking and Finance Overall lending activity remained relatively soft, although bankers reported slight increases in both household and business loan demand. Residential refinancing activity increased somewhat from its summer lull, but remained well below the peak reached in June. One banker said that margins on mortgage loans were being squeezed as firms that had built up "a huge mortgage lending infrastructure" competed for a smaller pool of potential borrowers. Some contacts also noted modest increases in home equity and credit card volumes. Household loan quality was reported to be largely unchanged. Business loan demand remained very soft on balance, though there were scattered reports of improvement in some segments. A few bankers noted increased lending to small businesses, and one saw a pickup in middle-market lending. For the most part though, large corporate borrowers remained on the sidelines. Business credit quality was said to be improving, and there were no changes reported for standards and terms. Prices and Employment Costs On balance, there was little change in the pricing and cost environments. Manufacturers of some products said that a weaker dollar enabled them to raise output prices from very low levels. However, producers of other goods attempted to push through price increases with limited success. Many retailers indicated that the long trend toward steeper discounts may be coming to an end, with one adding that "prices simply can't go much lower." Business contacts continued to report that higher energy and insurance costs were squeezing profits. To keep the rise in employment costs down, more employers were planning to shift higher health insurance premiums to their workers. In addition, several contacts reported that firms continued to limit and/or delay merit pay increases. Agriculture Crop conditions generally stabilized during September after deteriorating during August due to heat and lack of precipitation. In eastern portions of the District, however, harvesting was running behind average since fields were too wet and crops were maturing late. Corn yields across the District were coming in close to normal or above, but soybean yields were mostly below normal. Widespread spraying for aphids kept soybean yields from falling more, but boosted input costs. On balance, expectations for farm income have been reduced, potentially stressing farmers' cash flows and thus generating concerns about loan repayments. As a result, slower capital expenditures in farming are expected for the District, except for repairs. Nonetheless, strong competition between farmers and nonfarm investors persisted, driving farmland values and rental rates higher. With less development in some areas, there are signs that the role of tax-deferred exchanges in pushing up land values has begun to slow. Return to top Atlanta St. Louis