October 27, 2004

Eleventh District economic activity appears to have picked up slightly from late August to mid-October. Manufacturing activity strengthened some, and business services activity continued to expand at a moderate pace. Retail sales increased at a slightly slower pace than earlier in the year. Construction and real estate activity remained mixed. Bankers report continued increases in lending but weak deposit growth. The energy industry describes activity as very healthy but less than might be expected on the basis of current energy prices. The Texas cotton harvest in expected to be the largest in the state's history, about one million bales higher than the record 1949 harvest.

High energy prices and, to a much lesser extent, uncertainty about global terrorism and the pending presidential election have contributed to continued hesitation in hiring and investment, according to respondents. Still, most contacts have a very favorable outlook for activity and believe that the current expansion will continue to slowly improve.

Prices
There are more reports of price increases than in mid-August, particularly for energy. There are some reports of higher energy costs pushing up selling prices, but most contacts say stiff competition is causing these higher expenses to drain profits rather than boost selling prices.

A number of factors, including hurricane Ivan, low inventories and increased demand, helped push oil prices above $50 per barrel in October. Gasoline and heating oil prices rose along with the price of crude oil and were pushed up more after hurricanes shut down refinery capacity in Louisiana. Demand for gasoline was moderate, and inventories dropped below the five-year average. Heating oil and distillate inventories dropped sharply, and the price of heating oil and diesel rose to record levels (in nominal dollars). Natural gas prices also rose sharply, even though winter storage of natural gas is in good shape and headed for a possible record before the heating season officially begins on November 1.

Boosted by rising feedstock prices, prices have been rising for basic chemicals such as ethylene, as well as for a variety of intermediates and plastics such as polyethylene, polypropylene, PET bottle resin, polystyrene, and PVC. Primary metal producers say most input prices are still rising due to continuing growth of demand in China. Agricultural producers say high fuel prices are raising costs of fertilizers, chemicals, farm machinery operation and field irrigation.

Labor Market
There has been little change in the labor market. Most contacts indicate no wage pressures. There were very few reports of lay offs, but most

There are a few areas of tightness in the labor market. Accounting firms report that there is a bidding war for workers to support audit activities, with firms bringing skilled professionals from United Kingdom, Canada and India. Trucking firms report a persistent shortage of qualified drivers.

Manufacturing
Overall manufacturing activity appears to have strengthened some. Sales have been dampened as a result of hurricanes in Florida and the Gulf of Mexico. The Chinese economy remains a focus for some producers, both as a consumer and a competitor.

High-tech manufacturers report stable to slightly stronger growth in orders. Increased demand for consumer products such as MP3 players, video game systems and personal computers prompted a pickup in orders for semiconductors. Contacts say semiconductor inventories remain lean, even though technological improvements have increased capacity. Some respondents say that prices, which had been falling, have begun to flatten out over the past 30 days.

Demand for most paper products increased more than is typical for this time of year. Only producers of corrugated boxes reported weak sales that they attribute to customer resistance to an increase in selling prices caused by higher energy costs. Food producers say demand has picked up over the last several months. Demand for apparel products has been stable over the last 30 days, which is slightly higher than three months ago and up from a year ago.

Construction-related manufacturers, such as lumber, reported strong and steady demand, up from a year ago. The hurricanes caused some softening in demand for glass because clean up is delaying new construction. Demand for primary metals is up slightly, but there is concern that a slowdown in the Chinese economy will reduce demand for domestic metals that U.S. producers sell to China. Demand for fabricated metals has been high, but contacts say their inventory levels are also higher than normal.

Demand for petrochemicals is very strong, bouncing back from weakness in August and September. Producers say foreign demand has increased because oil prices have risen faster than natural gas prices, making U.S. chemicals, which are natural gas-based, more competitive than oil-based foreign production. Demand has been strong enough to allow producers to increase selling prices to cover higher costs and higher profit margins.

District refiners have operated at very high levels, partly in response to hurricane-related disruptions at other refineries. Falling inventories pushed up selling prices and profits. Hurricane Ivan reduced oil production capacity in the Gulf of Mexico by nearly 30 percent through mid-October and created a shortage of sweet crude used by most Gulf Coast refiners.

Services
Business services activity continues to expand at a moderate pace. Temporary staffing firms say activity is slightly stronger than a year ago. Demand is still strongest to supply workers for nondurable manufacturing. There have been few orders for workers to supply call centers, financial services or durable goods manufacturing. There were scattered reports of layoffs, and one contact noted that fewer workers have been promoted from temporary to permanent positions.

Accounting firms report continued strong demand, mostly due to increased audit and assurance services necessary to fulfill Sarbanes-Oxley requirements. Contacts say that firms have increased their workforce by as much as 25 to 35 percent to support audit work but hiring to support the tax side of the business has been soft. Law firms report that demand is unchanged or up slightly over the past 6 weeks, which is slightly weaker than earlier in the year.

High fuel costs are a major concern for transportation service firms. Only one airline said they were sufficiently hedged against higher fuel costs. With excess capacity and intense competition, few airlines expect to make a profit. The trucking industry says the business outlook remains strong, but they are concerned about the possibility of even higher high fuel costs. Railroads continue to see increased activity—hiring remains strong and investments in new technologies continue to help the industry expand capacity and streamline operations.

Retail Sales
Retail sales continue to grow but at a slightly softer pace than earlier in the year. Contacts say that high energy costs are taking a bite out of consumer's wallets and the simulative effects of tax cuts and low interest rates have waned. Still, contacts are optimistic about sales growth over the holidays, noting that consumer credit is in good shape. Automobile sales continue to decline and remain below last year's levels, especially among less fuel-efficient vehicles.

Construction and Real Estate
Homebuilding remains strong, although some contacts noted softer demand for mid-priced homes. Inventories are edging up for some builders, and incentives are increasing. Demand for existing homes has softened following three quarters of strong sales, causing inventories to inch up. Apartment markets continue to be burdened by an oversupply of units.

Office markets improved over the past six weeks, continuing their slow recovery. Contacts say demand for office space in Austin is picking up and Dallas recorded positive absorption for the first time in four years. Commercial construction continues to be driven mostly by public projects. Construction of health care facilities remains especially strong.

Financial Services
Bankers report little change in conditions with continued increases in lending and weak deposit growth. Commercial and industrial loan volume and traffic is up. Mortgage lending is flat or lower than last year. Demand for first mortgages is unchanged, according to contacts, but refinancing has dropped off considerably. Auto lending is also down. Competition for loans remains stiff. Rising interest rates have increased borrowing costs, squeezing net interest margins on fixed rate loans. Some contacts are pushing variable rate loans to help earnings.

Energy
Energy activity remains high, but domestic drilling has not responded much to higher oil prices. International activity continues to improve except in the North Sea and the international waters of the Gulf of Mexico. Contacts were optimistic about signs of a possible turnaround in North Sea activity.

Agriculture
High yields are expected to offset low cotton prices, but producers are concerned about high fuel prices and the removal of subsidies. Cattle producers continue to enjoy strong demand and high prices, despite the ban on beef exports to Japan and South Korea. Recent rains and cool temperatures have improved range and pasture conditions to the point where producers say conditions are conducive for herd expansion.