June 15, 2005

Eleventh District economic activity continued to expand. Manufacturing continued to be mostly strong but with some patches of softness. The service sector showed signs of picking up, while retail sales were up modestly. Construction and real estate activity remained unchanged at a high level. Financial service contacts said loan growth and credit quality remained good. Activity in the energy industry remained very strong, and contacts are very optimistic, but there is a lot of discussion about how long high prices can last. Agricultural conditions are favorable.

Prices
Contacts in most industries expressed concerns about high energy, fuel and freight costs biting into consumer demand and profits. Competitive pressures are limiting firms' ability to pass rising costs to their customers. Some companies are finding ways to reduce consumption. For example, a retailer said that they have "reengineered standards" to reduce use of petroleum-based products, such as using plastic shopping bags that are smaller and thinner. Other firms say they are continuing to find ways to increase labor productivity to counter rising input costs.

Crude oil prices have varied from less than $50 to more than $55 per barrel. Demand for gasoline was down compared to earlier this year and is now more similar to a year ago. Gasoline inventories are high; 4 percent above the 5-year average and at the highest level since May 1999. Natural gas prices fell from over $7.50 per million Btu to near $6.50. Natural gas inventories continued to grow and are now more than 20 percent above the 5-year average.

There were reports of rising fees for business services, such as accounting and legal. Prices for manufactured goods were mixed. Prices were up for construction-related materials, such as lumber, cement, brick, tile and glass. Primary metal manufacturers said that high energy and raw material costs have lead to some price increases, but persistently idle international capacity and a recent softening in steel and aluminum prices have reduced the threat of a price-rise in the near future. Paper producers say that heavy inventories have pushed down prices. Prices have fallen for all of the basic chemicals and most plastic intermediates.

Labor Market
The labor market continued to strengthen, with more reports of hiring at all levels. Wages were rising in the service sector, but there were few reports of rising wages for nonprofessional workers. Nearly all contacts expressed concerns about the high cost of benefits, particularly health care, and some said that these costs are restraining hiring. Skilled workers were in short supply in the energy industry, and a few industries reported that management level workers were being bid away.

Manufacturing
Manufacturing activity was mixed. Demand was up for construction-related products, including lumber, cement, brick, tile and glass. Contacts attributed the increase to continued robust construction activity, specifically strong housing starts and some commercial and infrastructure work. Cement is in short supply and is on allocation in some areas. Producers of fabricated metals reported solid sales, stimulated in part by increased demand to support construction activity and to supply the construction of wind turbines to generate electricity.

Demand for food products continued to be strong. Apparel manufacturers said demand has been growing over the past month. In the last six weeks, one firm has hired 100 new workers overseas and about 30 domestically. Respondents in high-tech manufacturing said that growth in orders has increased slightly since the last survey. Much of the pickup occurred in the consumer sector. Sales to industrial customers continued to grow at a moderate pace. Telecommunications manufacturers reported a slight increase in demand.

Demand for corrugated boxes softened slightly. Contacts say there is still overcapacity in the industry and competitive pressures may cause some businesses to close. Demand had also softened for primary metals, although demand remained higher than a year ago.

Chemical producers reported an unexpected slow down in demand from Asia, particularly China, and inventory has shifted from shortage to oversupply. Contacts say the slowdown is not severe but was not expected. Production was reduced slightly but remained at high levels. Refining utilization rates on the Gulf Coast were hurt by a series of outages. Refined product imports were at the highest levels of the last five years and 9 percent higher than last year.

Services
Temporary staffing firms reported increased activity, up significantly from year-earlier levels, with almost all areas performing well. Demand for telecommunications services was up slightly, with continued strong demand for wireless services. Demand for legal services has been steady, driven mostly by corporate transactions, real estate deals and litigation work. Accounting firms reported mixed results.

The transportation industry continued to report strong demand and serious concerns about high fuel costs. Railroads say the strongest demand is for shipping metallic ores, crushed stone, construction products and trailers. Contacts said rail shipping rates continued to rise, but the pace of increase seemed to be slowing. Trucking activity also remained strong and above year-ago levels. The airline industry continued to report strong demand in domestic markets but limited ability to raise prices, although carriers reported slightly higher fares in some markets. Carriers are moving capacity to international routes because fares are higher.

Retail Sales
Retail sales increased modestly. Contacts said sales growth continued to be dampened by high gasoline prices biting into consumers' pocketbooks. Retailers that issue their own credit cards say credit quality trends are positive, with low delinquencies. Auto sales were mixed, and some dealers reported that inventories are higher than desired.

Construction and Real Estate
Housing markets were strong overall, but there continued to be reports of slowing from last year's pace in some metropolitan areas. Home sales are about even with last year's levels, but builders in Dallas and Houston said new home construction has outpaced demand. Rising input costs continued to put pressure on builders' margins because heavy competition has left no room for price increases. Austin remained an exception, where sales have picked up from last year's rate and builders are able to raise prices. Existing home sales were strong across the District, except in Dallas, where sales have slowed and dipped below last year's levels. Contacts are optimistic that recent job gains will spur a pick up in sales.

Demand for apartment space increased in Dallas and Houston but continued to be overshadowed by what many perceive as excess development. Rent concessions have picked up, especially in Houston. Contacts said Austin's multifamily housing market is not overbuilt, but they also expressed concerns about the possibility that new development under consideration could generate an oversupply.

Office markets continued to improve and the pace has picked up slightly, according to contacts. Dallas, Houston and Austin have witnessed positive absorption so far this year. Contacts say investment activity is at a record high.

Financial Services
Loan growth remained solid, and credit quality is good, according to contacts. The market is extremely competitive, however, and pricing remained a challenge. Respondents are optimistic about the economy and future loan growth. Still, contacts expressed concern about a potential glut in multi-family residential properties, and the possibility of some land price bubbles, particularly in rural areas located near big cities.

Energy
Drilling activity remained strong, with little change in the number of working rigs. In the United States, more rigs have turned to natural gas as the market for rigs has tightened, and only about 11 percent are now directed to oil. International drilling continued to pick up.

Demand for oil field services has been very strong. According to contacts, oil field service companies are raising prices rapidly, and margins are improving. Backlogs are long, and companies are turning down work. Capacity is being expanded in critical areas. Day rates are skyrocketing for land and offshore rigs. Skilled workers are the critical constraint in any effort to expand, according to contacts, who say engineers, truck drivers and drilling crews are particularly in short supply.

Agriculture
The planting season continued to progress well, and most planted crops are thriving, according to contacts. High fuel, irrigation and fertilizer costs remain a serious concern for farmers. The cattle industry is profitable, according to ranchers, who say they are expanding their cow-calf herds. Pasture conditions and prices are favorable, but contacts expect cattle prices to decline in coming months.