January 14, 2004 Federal Reserve Districts Eleventh District--Dallas

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Eleventh District economic activity expanded modestly from mid-November to early January. Contacts expressed optimism about the outlook for 2004 and are increasingly taking steps to increase capital spending and hiring as a result. Manufacturing activity continued to recover, while the demand for business services strengthened modestly. Retailers reported that holiday sales were good but not great. Conditions were mostly unchanged for the energy industry and for real estate and construction firms. The beef industry has been disrupted by fears of "mad cow" disease, but there was little change in other agricultural conditions. Prices Energy prices are higher. Natural gas prices jumped over 40 percent in December. U.S. crude oil prices were up in response to OPEC production restraint, terror uncertainties, cold weather, higher tanker rates and very low crude inventories in the U.S. In December, crude inventories twice set records for the lowest levels ever seen during the month. OPEC has not responded to prices above their announced target range for a variety of reasons including a weaker dollar and expectations that supply will be stronger in the spring. Heating oil prices have been volatile but ended the period up slightly-responding to cold weather, a spike in natural gas prices, and higher crude prices. The price of regular gasoline was stable at $1.48 to $1.50 per gallon throughout the period, although December pump prices were the highest ever for a December. Gasoline demand has been running at rates above the five-year maximum all year, including November and December. The spike in natural gas prices was a shock to large users like petrochemical producers. Domestic producers absorbed the additional costs, hurting profit margins. Prices for plastic resins remained stable in December. High natural gas prices have led to a moderate rise in the price of cement, sand, gravel and aluminum, and one respondent expressed concerns about being driven out of business by natural gas cost pressures. Transportation firms reported concerns over rising fuel prices, although their ability to pass these cost pressures onto selling prices is mixed. Intense competition is keeping trucking prices unchanged, but strong demand is allowing some price increases for rail shipments. Airlines say selling prices continue to be soft. Producers of primary and fabricated metals say input prices have skyrocketed. Shortages of steel, scrap and rebar were reported. Apparel prices continue to face downward pressure from tough global competition. Prices for most telecommunications and electronics products continue to decline. Retailers say that prices are declining at a slower rate. Auto dealers report that input prices and manufacturer incentives are unchanged, but selling prices continue to decline. Labor Market The labor market appears to be strengthening slowly with scattered reports of increased hiring. Still contacts report concerns about rising costs for health care and other employee benefits, including an increase in the Texas unemployment tax. Rising wage pressures are reported for some types of workers, such as skilled mechanics and clerical workers. Temporary service firms say wages and salaries have increased 3 percent to 4 percent in the past quarter, but individuals that were making about $15 an hour in 2001 are currently making about $13.50 an hour. Financial stress continues to exert downward pressure on wages and employment levels in the airline industry. Manufacturing Manufacturing activity was improved for most products, including food, metals, lumber and paper products. Apparel producers reported no change is sales growth over the past month and say tough global competition continues to put pressure on the industry. An exporter of manufactured equipment noted an increase in projects in the Middle East following the capture of Saddam Hussein. Demand for construction-related products, such as concrete, brick and glass, has been better than expected, which contacts attribute to favorable weather conditions. The outlook is "cautiously optimistic." Producers are cautious because of high natural gas prices and uncertainty about interest rates, but are optimistic because of productivity improvements achieved by modifying the mix of fuel content and the start of new public and commercial construction projects. Respondents in high-tech manufacturing reported a continued moderate growth in orders with a slight acceleration in orders for latest-technology products and research. One respondent noted that the recent improvement in the economic outlook has motivated companies to increase their investment in cutting-edge technology so that they can stay ahead of the competition. Inventories were reported to be close to desired levels with retailers keeping lean inventories, and one manufacturer reporting that they were trying to build inventories. Contacts said they continue to outsource functions such as logistics and information technology to companies in the U.S. and overseas. Most contacts expect sales to grow at a 5 percent to 10 percent annual rate over the next three-to-six months. Telecommunication manufacturing firms reported continued slow recovery, with demand up slightly and inventories declining slowly. The decrease in inventories and the growth of broadband use has helped to boost future prospects for the industry, although a robust recovery is not on the horizon. Domestic employment levels are not expected to increase, but plans to hire or outsource in the Asian Pacific region, particularly China, could boost worldwide employment. Refiners raised production levels in response to cold weather and higher heating oil prices. Imports of refined products have been running at high rates, above the five-year maximum. Petrochemical markets continued to be plagued by overcapacity, despite rising demand from an improving U.S. economy. High natural gas prices have resulted in the loss of most export markets, further worsening the overcapacity situation. Producers are also facing growing competition from foreign producers for domestic markets. Services Legal firms reported robust growth in the fourth quarter. Litigation activity was still strong, and transactional/venture capital activity continued to strengthen. One contact noted a slowdown in bankruptcy work. Accounting activity was flat. Temporary service firms reported only a slight increase in activity. Demand is strongest to supply health care workers, but orders grew considerably for IT and light industrial. Demand for workers to supply call centers and administrative/clerical positions have been weaker than expected. Transportation firms, including trucking, airline and rail, reported increased demand. Rail shipments of grain have been boosted by good crop yields in the U.S. and higher demand from abroad. There has also been an increase in rail shipments of lumber and wood as a result of sustained growth in the housing construction market. The airline industry continues to improve modestly. Holiday demand was stronger in 2003 than in 2002, but demand was weaker than expected, which contacts attribute to the increased homeland security alert status. Retail Sales Retail sales started the holiday season slowly but ended it with a flourish. Overall contacts said that sales were good but not great. The industry remains very competitive, but contacts say there are fewer massive promotional efforts because consumers expect low prices and aren't attracted to the "loud noise of discount." Inventories are in good shape. Auto sales remain flat. Construction and Real Estate On the commercial side, office market fundamentals remained weak, but respondents are increasingly optimistic that the worst is behind them. Still, most contacts don't expect a major improvement in office markets until late 2004 or early 2005. Industrial real estate continues to perform relatively well, and most contacts in that industry are cautiously optimistic that demand will remain steady in the first quarter. On the residential side, multifamily markets remain soft, with little change in demand. Apartment construction has subsided some, according to contacts, but there are still significant projects in the pipeline. While vacancy rates have flattened, there continues to be downward pressure on rents. Single-family builders say demand is flat to down, and fierce competition is keeping a lid on price increases. Contacts in the existing home market remain concerned about the amount of inventory available to buyers. Most single-family respondents were guarded in their outlooks, hoping for a pickup in job growth in 2004. Energy Crude oil demand has been at levels well above the five-year average since October, but there has been little change in energy activity. The domestic rig count remained near 1100 and drilling in the Gulf of Mexico is at a depressed 100 rigs. International drilling continues to improve. There continues to be excess capacity in the oil services and machinery industry, leading to sluggish pricing and moderate profits. In 2004, producers expect U.S. oil drilling to decline roughly 7 percent from current levels. International activity is expected to increase 6 percent. Agriculture Crop conditions were mostly unchanged, but the first U.S. case of "mad cow" disease led to a significant drop in cattle prices. Thirty-five international markets closed their borders to U.S. beef. Contacts consider U.S. beef safe but say cattlemen may delay liquidating herds, reducing beef production in 2004. Some contacts were hopeful that Mexico and Canada would soon re-open their borders to U.S. beef. However, most contacts were uncertain about how the American consumer would respond while the extent of the disease in the U.S. is being determined. Return to top Kansas City San Francisco