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Federal Reserve Districts

Eleventh District--Dallas

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The Eleventh District economy continued to expand at a moderately strong pace in April and May. There was modest improvement in the service sector. Manufacturing remains at a moderately high level. Home sales and construction continued to soften, but commercial building is robust, and leasing was more active than expected. Commercial lending continued to increase, but consumer lending still softened. Energy activity has flattened at a high level. Agricultural conditions are mostly favorable.

Many contacts have become more optimistic about the outlook for economic activity, partly because the actual effects of weakening housing markets and the pullback in subprime lending has been less than feared. Nevertheless, high freight and energy costs remain a concern for most contacts.

Energy prices have been high. West Texas Intermediate Crude oil has hovered around $65 per barrel. Brent crude prices have been nearly $7 higher. Natural gas prices are nearly $8 per million Btu. Prices continue to rise for some petrochemicals.

There is widespread concern about inflation in food prices. While higher freight and energy costs have contributed to higher prices, contacts in several industries say increased demand for ethanol has led to very high corn prices that are pushing up prices of many products, including corn starch, beef, poultry, eggs and dairy products. Several contacts said the price of milk powder--a partial substitute for milk as well as an ingredient in other products, such as bread--is at an all-time high and is expected to continue rising. Agricultural producers say the high cost of fuel and fertilizers are boosting costs.

Construction costs remain high, and contacts say building material prices are moving up again, including copper, steel, aluminum and composite aluminum substitutes. Land prices remain very high. Office rents are rising more than expected. Home prices continue to soften, however, and prices have fallen for products sold to home builders, such as lumber. Auto dealers say rising incentives and rebates have resulted in lower selling prices.

Labor Market
The labor market remains very tight for workers with specialized skills, such as CPAs, accountants, MBAs, auto mechanics, engineers and those with experience in commercial construction and the energy industry. Commercial banks report a shortage of tellers, and one contact said high school graduates no longer have sufficient math, writing and communication skills for these jobs. Wages have risen for workers in short supply--in some instances substantially.

Some firms continue to report hiring and wage pressure for unskilled workers and managers, but other firms say this market has loosened some. A few firms are laying off these types of workers to increase productivity. Most homebuilders are reducing staff because of weaker sales, and the market for subcontractors has softened.

Manufacturing activity remained at a moderately high level, but reports were mixed. Some manufacturers continue to report strong demand, such as those producing transportation equipment, chemicals and items supporting the energy industry. In addition, demand for food products was up slightly. However, sales of products to homebuilders remain sluggish, and high-tech activity is mixed. Producers of corrugated boxes say demand remains solid, except for packaging for some construction-related goods. While many manufacturers reported that inventories are in line with their plans, some firms said they are intentionally increasing inventory of inputs in advance of anticipated price increases. More broadly, the decline in the value of the dollar has raised input costs for some firms but stimulated export growth for others, such as computers and petrochemicals.

There was little change in demand for construction materials, such as stone, clay and glass. The volume of new orders and sales remained flat or below last year's levels for all respondents. Orders from home builders remained soft, but demand remains solid for commercial construction and home remodeling. Inventories are higher than desired. Demand for lumber products was mixed. Some producers say demand is steady, particularly for upscale housing and commercial building, but sales to middle and low-end home builders remain sluggish. Producers of primary metals report some softening of demand in the past month, although they say activity is not as sluggish as earlier this year. Demand continues to be weak to supply residential construction, and contacts say less expensive imports are eating into market share.

High-tech activity is mixed. Several firms report continued moderate sales growth. Some contacts have seen recent improvement that has led them to be more optimistic, but others say there is still a lot of uncertainty in the industry. Excess inventory of some products, such as memory, has led to some stockpiling, but inventory is tight for other products, such as silicone and glass for flat panel computer screens. Overall, input costs are down, and selling prices are on their typical downward trend.

Gasoline demand remains healthy--with inventories 6 percent below their five year average--output is well above a year ago, and imports are strong. Chemical production is above last year's record pace. Domestic demand for petrochemicals has been modest, although there has been some recent improvement, partly to rebuild inventories. Export demand remains vigorous. Higher costs have squeezed margins some, although margins are generally healthy. Synthetic rubber is an exception, where domestic demand has been hefty and higher costs have been easily passed through to selling prices.

Legal firms say overall activity was up, with strong demand for corporate transactions but weak demand for litigation and bankruptcy. Accounting firms report very strong activity. Demand for specialty services is robust, but growth in audit and consultancy services has leveled off. Temporary service firms reported a slight softening of orders to some manufacturers, but demand was hefty to supply workers to accounting and IT services.

Transportation activity has improved. Trucking business has picked up. Cargo volumes have improved at small parcel shipping firms. Container trade remains robust, with growth largely from overseas markets. Airlines report vigorous international activity. Domestic demand remains moderate. Costs continue to rise, particularly for fuel, but competition has pushed down fares.

Retail Sales
Retail sales were weaker than expected in May, but most retailers have not lowered their outlook. Recent softness was mostly attributed to high gasoline prices and unusually wet spring weather. Retailers report that repayment rates on revolving credit continue to drop, suggesting customers are under financial pressure, although they note there has not been an increase in defaults, indicating customers are dealing with those pressures. The decline in the value of the dollar has raised costs for some retailers, who report higher prices for imported products. The retail environment remains very competitive, keeping pressure on selling prices. Product prices are rising, however, and several retailers noted the importance of keeping a balance between maintaining reasonable prices and profits. Demand for autos was unchanged and roughly the same pace as a year ago. Dealers say an inventory overflow mentioned in previous reports has been reduced to manageable levels.

Construction and Real Estate
Housing markets remain soft, although contacts say demand is better than in many other areas of the country. Dallas-Fort Worth builders continued to reduce starts and expect price cuts on unsold inventory. Cancellation rates are still high in Dallas but have improved since March. Houston's housing market slowed since the last survey, despite solid job growth. San Antonio has quickly become a buyers market, with a rising supply of new home inventory and incentives "rising through the ceiling." Sales of new and existing homes continue to rise in Austin, but builders are cutting back because new home inventories are higher than desired. A recent pick up in leasing activity led respondents to be a bit more optimistic about apartment markets.

Commercial markets improved. There are signs that office leasing is picking up. Construction of office space is still strong in Dallas and picking up in Fort Worth, Houston and Austin. Warehouse leasing activity improved. Industrial investment remains steady, and selling prices are high but attractive to investors because they are much less expensive than coastal markets, according to contacts.

Financial Services
Commercial lending continues to increase and is above last year's solid gains. Credit quality is good, according to contacts, who say competitive pressures exist on pricing loans and to attract deposits. Consumer lending continues to soften, particularly for real estate and autos. Still, respondents remain optimistic, and some have improved their outlook because of reduced uncertainties regarding housing problems.

The Texas and U.S. rig counts have been flat for most of this year, albeit still at historically high levels. New rigs are entering the market, putting downward pressure on rates. Older rigs are being refurbished, repaired or stacked to await new work. The lack of growth in drilling has hurt pricing of tubulars and services, such as pressure pumping. Still, backlogs remain long, delivery can be slow and pricing is highly profitable. The high cost of engineering and construction remains a barrier to expansion in the industry, causing many projects to be delayed or cancelled.

International activity is growing; with large, long-lived projects; backed by sponsors with deep pockets; using sophisticated, high-margin services. Rigs continue to leave the Gulf of Mexico, attracted by higher rates in the strong international market.

Widespread rain and mild temperatures meant good progress for crops, and wheat yields are expected to be excellent. Cattle grazing conditions also improved, and livestock are in superior condition. Wet conditions temporarily halted cotton and sorghum planting and delayed the hay harvest.

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Last update: June 13, 2007