March 3, 2004

Eleventh District economic activity showed signs of accelerating from early January to mid-February. Contacts expressed increased optimism about the economic outlook but had mixed views about the strength of expected activity in the second half of 2004. Manufacturing activity continued to strengthen, and retail sales were up. There was little change in service sector, energy, construction, financial services, real estate activity and agriculture.

Prices
Energy prices remain relatively high putting upward price pressure on other products and services. Crude oil prices have remained in a range of $32-$35 in the first six weeks of 2004. U.S. crude inventories averaged near 270 million barrels since January, about the level set by the National Petroleum Council as critically low, and at one point hit the lowest levels since 1982. Prices and inventories have been driven by strong demand, a weak dollar, restrictive OPEC quotas, and higher tanker rates. Looking ahead to the possibility of weaker demand in the spring, OPEC announced a quota reduction of 4 percent to 23.5 million barrels per day, but actual compliance would mean nearly ten-percent less production.

Heating oil prices, near 90 cents in late December, were pushed over $1 per gallon by cold January weather and high crude prices. However, high inventories of distillates and warmer weather have put downward pressure on prices in recent weeks. Gasoline demand has been strong, and gasoline prices have been rising as heating oil retreats, with wholesale prices over $1 per gallon. At the pump, (nominal) prices have been the highest ever seen in January and early February.

Natural gas prices rose sharply with winter weather in early January, and spot prices peaked at the Henry Hub around $7.00 per million Btu. Inventories so far this year generally have remained above the five-year average, with cold weather not pulling them below normal for this time of year. Milder weather in late January and February pushed prices back to near $5.

A number of industries reported upward price pressures—as a result of stronger demand, input cost increases and a weaker dollar. Prices of food products have started to rise, according to contacts, as a result of higher input costs; flour and shortening costs are up 15 percent over the past month. High fuel prices remain a concern for transportation firms. Strong rail demand pushed up prices, but intense competition between airlines is keeping a lid on fares.

Prices have risen for some construction-related products. Producers of cement are very excited because this is the first price increase in 2 to 3 years. Heavy demand and low inventories pushed up lumber and timber prices. Prices for some final products, such as doors and cabinets, have remained steady but are expected to increase in 2005.

Paper manufacturers say their customers are increasing inventory in response to an announced 10 percent price increase planned for early March. Paper manufacturers say customers expect to be able to pass roughly 50 percent of this price increase on to consumers. High petroleum prices have increased the price of resin and box liners.

Inventories are low for fabricated metals, with shortages of scrap steel becoming more pervasive. Producers of fabricated metals report that input commodity prices have risen sharply. Primary metal producers also report concerns about shortages of inputs, including copper and scrap steel. Producers of primary metals report that soaring input prices are pushing up selling prices, although one contact said profits are up as well. High tech firms report that inventories are at desired levels and, while overall prices were sluggish, there were some increases in semiconductors prices.

Many contacts expressed continued concerns about high insurance costs but say the rate of increase has subsided. Some industries also reported concern about the increased cost of state unemployment insurance and municipal real estate taxes.

Labor Market
There were more reports of hiring in both the service sector and in manufacturing, although reports remain scattered, and there is little pressure on wages. Temporary service firms say competition for business remains stiff and that wages have yet to recover from declining during the recession. One client reported that average salary for temps has fallen 2.7 percent year over year.

Manufacturing
Manufacturing activity picked up. Producers reported strong demand for food products, primary and fabricated metals. Apparel producers reported increased demand and noted that the downward pressure on selling prices had forced them to increase outsourcing. Demand for lumber was up. Paper producers report some signs of strengthening sales, including an increase in box shipments, but it is difficult to gauge the overall change in demand because some box plants are closing. The long-term outlook for this industry is pessimistic because international competition is reducing overall demand. Unfavorable weather conditions dampened demand for some construction-related products, including stone, brick and glass, and slightly inflated inventories.

High-tech manufacturing conditions continue to strengthen. Manufacturers of electronics and communications devices said that shipments have picked up and strength in orders suggests continued strong activity in the second quarter. Demand was reported to be coming from a broader area of the world with some pickups occurring in Europe and Latin America and continued strength in North America and Asia.

Petrochemical activity was up, including increases in demand, capacity utilization, and margins for ethylene, polyethylene, propylene, chlorine and PVC. Stronger U.S. industrial activity helped boost demand, but sales were also stimulated by major outages in Europe and Venezuela. Activity is expected to weaken some as these outages are restored and as a new ethylene plant starts up on the U.S. Gulf Coast. Strong demand for heating oil and gasoline boosted refining activity and profits. Imports of refined products were at the top of their five-year average.

Services
Demand for legal services is unchanged. Bankruptcy work continues to slow, while litigation and real estate remains strong. Legal contacts report hearing increasingly positive attitudes from clients, yet some uncertainty lingers. Demand for accounting/consulting services is strong and is up from last quarter. There is increasing interest in transactional work, capital raising and IPOs.

Demand for temporary staffing services is improving slowly. There continues to be strong demand for workers to supply the health care industry, and demand for workers to supply most other sectors has bottomed out. A lot of call center work and some IT (programming) jobs are being sent overseas, though there continues to be rising demand to provide call centers in some regions.

Trucking firms reported a seasonal drop in demand but expect activity to pick up seasonally. Demand for rail shipments was robust and surpassed shipping activity levels both year-to-date and during the last four weeks across all categories except for motor vehicles. Demand was particularly strong for shipments of grain and to support ocean freight. The airline industry remains very competitive. Some airlines report improved demand while others report that demand remains soft.

Retail Sales
Retailers report strengthening sales in most categories. Contacts are cautiously optimistic that sales will continue to strengthen, with one noting that consumers are willing to spend on more frivolous products. Auto dealers report unseasonably low demand that has left them with high inventories, lower selling prices and slimmer profit margins. Manufacturers continue to increase incentives to keep sales from declining further.

Construction and Real Estate
Contacts say the long downward trend in office demand seems to have reversed in the major metros because rents are declining less rapidly. Capital demand for real estate remains especially strong in Dallas/Fort Worth suggesting investor optimism remains high. Commercial developers say there is steady demand for retail, healthcare, and school buildings.

Apartment markets continued to weaken, with Dallas/Fort Worth and Houston posting the lowest occupancy rates in a decade. Rents are still falling, and concessions remain prevalent. Single-family construction continues to rise at a good pace. Competition has kept a lid on home prices despite increases in some building materials.

Financial Services
Contacts say that deposit growth has slowed, which they attribute to money flowing back into equity markets. Several respondents commented that CDs and other instruments are being liquidated. Overall lending activity has been unchanged; mortgage activity is down, mostly because of a drop in refinancings, but commercial and industrial activity has picked up and consumer categories remain positive but unchanged.

Energy
Although the industry is expressing optimism about market conditions, there was little change in drilling activity. The U.S. rig count held steady near 1100 working rigs through the first six weeks of this year, almost exactly equal to the average for the second half of 2003. Activity weakened in the Gulf of Mexico to fewer than 100 working rigs on the U.S. side, although utilization rates and day-rates for rigs working in the Gulf as Mexico have picked up slightly in recent months, largely because of increased activity on the Mexican side of the Gulf. As Mexico has added 20 offshore rigs to its drilling programs in the last 12 months, it has drawn rigs out of U.S. waters. International activity continues to slowly improve as it continues to shift from the U.S. Gulf of Mexico and the North Sea to the Middle East and former Soviet Union.

Agriculture
Cooler temperatures and snow slowed growth of winter pastures, but contacts are optimistic because the snow helped soil moisture. There were no reports of serious damage to crops or livestock from the freezing temperatures. Bad weather dampened 2003 cotton yields but higher cotton prices were received for the crop. Citrus producers reported a good crop. Cattle producers noted that the "mad cow" scare did not affect beef demand or prices as much as expected.