May 2006

Most Indicators Signalling Expansion

The Texas economy is growing quite strongly. Reports of capacity constraints limiting activity are increasing. However, there is evidence of financial strain. Still, economic growth in the state appears to be stronger than elsewhere in the country, and most indicators signal continued expansion.

Texas job growth was recently revised up from 2.7 percent to 3.1 percent for 2005 (Chart 1).[1] First quarter 2006 job growth is currently estimated at an annualized 2.1 percent, which is weaker than suggested by the Beige Book. It is likely that 2006 growth estimates will be revised up.

Texas employment has grown 0.8 percent per year faster than the nation since the end of the state's recession in July 2003. Of this growth, 0.1 percent is due to a slightly larger share of fast-growing industries in Texas, while 0.7 percent is attributable to Texas firms growing faster than their national counterparts.

Increasingly there are reports in the energy, manufacturing and service sectors of expansion being limited by a shortage of skilled labor. Some contacts also report difficulty finding entry-level workers who can meet the basic qualifications of employment, such as background checks and drug tests.

The Texas unemployment rate has held firm at 5 percent for January, February and March 2006—the lowest it has been since the state fell into recession in 2001. While the unemployment rate has been unchanged this year, the labor force growth has been relatively strong, and job growth has been sufficient to absorb the increase in workers.

Construction Is Building
Nonresidential construction has picked up in recent months, and nearly half of Beige Book contacts said in April that they have started or plan to start major new construction activity this year. Most firms say construction spending is higher this year than in 2005.

After torrid growth in 2005, housing activity took a slight breather over the winter, leading some contacts to express fear that the nationwide housing slowdown might affect local markets. Existing home sales dipped in Fort Worth, San Antonio and Dallas after posting very strong gains in 2005 (Chart 2). Statewide permits, contract values, and existing home sales softened slightly over the winter, but Texas single-family permits and contract values increased in March. While contacts remain concerned about news reports of slowing home markets in other parts of the country, the recent pick up in activity has led contacts to become more confident that local markets will be unaffected.

Texas home prices, which have been subdued in most markets, recently began to post gains, pushed up by strong demand and low home inventories (Chart 3). While there are reports of some investor activity, price gains appear driven by economic fundamentals.

Energy
The energy industry continues to be very strong, with activity restrained by shortages of rigs, downhole equipment and skilled labor. Oil service firms report growing backlogs and an increasing rejection of work that cannot be scheduled.

The Texas rig count rose to 717 in April, pushing past 700 working rigs for the first time since 1985.

Gasoline prices jumped sharply in recent weeks, driven up by strong demand, rising crude oil prices and the industry’s inability to meet new regulatory requirements. Texas gasoline prices, though typically below the national average, have been slightly higher in the state than in the U.S., largely because of shortages of ethanol required to meet new regulations (Chart 4).

Financial Strain
There is growing evidence that some Texans are facing financial strain. This does not appear to be undermining the overall expansion.

Beige Book contacts say that sales have been weakest to low-income consumers who, they suggest, are paying a larger share of disposable spending to high utilities and gasoline costs.

There has also been an uptick in mortgage delinquencies, although it is hard to separate the effects of the general economy from those caused by changes in the bankruptcy law and recent hurricanes (Chart 5).

Texas banks report good credit quality, but loans to Texans have deteriorated in quality in recent months. Texas has a disproportionate number of subprime and FHA loans, which tend to be riskier loans (Chart 6).

Mortgage delinquencies may be higher in Texas because, unlike in other parts of the country, the state has not had the home price appreciation that would allow homeowners to extract equity from their homes to pay down bills. However, the recent increase in Texas home prices may help ameliorate this situation because it would make it easier for homeowners to take out equity loans to pay debts or sell their homes at a higher price than their mortgage liability.

Texas has a lower percentage of adjustable rate mortgages (ARMs) than other states, making homeowners less vulnerable to rising mortgage rates. In 2004, about 19 percent of Texas loans were ARMs—45 states have a higher percentage of such loans.

Outlook
The Dallas Fed’s Texas Leading Index, a composite of Texas indicators that predicts economic activity, continues to signal expansion. The recent rise in the index has been the result of increases in average weekly hours worked, Texas stock index, well permits, oil prices and a drop in new unemployment claims. The Dallas Fed continues to expect Texas job growth for 2006 to be roughly 3 percent.

—Fiona Sigalla

Notes FRB-Adjusted Texas Employment was recently revised for the third and fourth quarters of 2005. Data for the fourth quarter was revised up, based on a benchmarking to the just-released fourth quarter Covered Employment and Wages data. Third quarter data was revised slightly down.