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Conditions in the Seventh District economy in June and July again were characterized by modest expansion and very tight labor markets. Consumer spending remained strong, led by resilient demand for home-related items and light vehicles. Construction activity was again robust, but some realtors and homebuilders lowered their expectations for the coming months. Exceptional motor vehicle production, both light vehicles and heavy trucks, led a robust manufacturing sector, despite some segments continuing to struggle. Increased demand for business loans offset a notable decline in residential refinancing, as overall lending activity remained brisk. Worker shortages continued to hinder some regional firms' expansion plans, and there were a few new reports of intensifying wage pressures. Overall crop conditions were good, but deteriorated in some areas as a result of hot, dry weather. Commodity prices remained low, and a survey of agricultural bankers suggested that farmland values declined in some areas during the second quarter.
Most retailers indicated that sales in June and July were moderately above last year's results and in line with their expectations. As in our previous reports, sales of items related to the home (furniture, electronics, lawn and garden, etc.) continued at a very strong pace. Most contacts noted, however, that mid-summer sales of many products are typically slow and that "back-to-school" sales beginning in August will better reflect the underlying strength in consumer spending. District auto dealers reported that sales in July slowed somewhat from the torrid pace in May and June, yet showroom traffic remained high and demand strong. One auto dealer noted that bank financing rates had increased noticeably in recent months and expressed surprise that this had not hampered sales to a greater extent. Most retail contacts expect consumer spending to remain strong in the near term, citing tight labor markets and high consumer confidence as contributing factors. Overall retail inventories were reported to be in good shape and there were no new reports of significant discounting or price increases at the retail level.
Construction and Real Estate
Overall construction activity was robust in June and July, while expectations for the coming months appeared to be slipping. A national report showed existing home sales in the Midwest up significantly in June and realtors in the District indicated that July's sales, while somewhat slower than in June, were very strong and above year-ago levels. A national survey of homebuilders showed a similar pattern in new home sales. The index reflecting sales in the Midwest fell in July from June's very high level, yet was above last July's reading. Both realtors and homebuilders had lowered their expectations since our previous report, with one realtor expressing the general sentiment that the housing market "has been so good, for so long, you just wonder if it can keep up." Commercial construction activity remained strong, very similar to the conditions noted in our last report. Office vacancy rates were again very low, leading to new construction projects in some metro areas. One contact in the Chicago area noted that some real estate professionals were "a little concerned" that the hotel segment was being overbuilt. Shortages of wallboard and labor persisted in the District, which builders cited as hindering some projects.
Led by exceptional strength in motor vehicles, manufacturing activity remained robust in the District, although some industry segments showed signs of softening. Light vehicle sales nationally retreated slightly in July, from very high levels in June, but remained exceptionally strong and contacts suggested there were no signs of softening demand. Incentive spending was higher than some industry contacts expected even as inventory levels were reported to be in line with sales expectations. Sales of class 8 heavy trucks set records in recent months as cancellation rates decreased and backlogs increased. On the other hand, sales of class 5-7 trucks were headed in the opposite direction, with new orders slowing, cancellations increasing, and inventories building. Orders for construction equipment were reportedly softening and some industry contacts expected sales for 1999 to be flat with last year, if not down slightly. The agricultural equipment sector continued to struggle, with industry sales off about 35 percent from last year. Wallboard producers, noting continued strength in housing, increased prices about 15 percent year-to-date through June, even as new capacity was coming online. Demand for steel was said to be down slightly since our last report and prices remained below year-ago levels, but were recovering somewhat. More generally, purchasing managers throughout the District reported an increase in prices paid in July.
Banking and Finance
Lending activity remained brisk in June and July, despite a notable drop-off in residential refinancing activity as mortgage interest rates increased. Business lending continued at very high levels with contacts at District banks describing activity as "booming" and "vigorous…the fastest pace in a decade." One banker suggested that strength in demand for business loans had offset significant competition for those loans, allowing the bank to firm its pricing. Some lenders have been looking at commercial loans with a more discerning eye, with a few noting that chargeoffs on commercial loans had increased modestly in recent months, though not significantly. Overall consumer lending activity remained high, resulting largely from strong sales of homes and light vehicles. Rising mortgage interest rates led to a significant decrease in the number of home refinance loans, but strength in new and existing home sales mitigated the loss of volume. A contact at one large money center bank reported that the wave of refinancing activity earlier in the year left consumers with improved balance sheets, resulting in fewer consumer loan chargeoffs.
Tight labor markets and worker shortages persisted in the District in recent months despite a slight increase in unemployment rates. State employment agency analysts attribute this slight increase to a surge in labor force participation in excess of the rate of employment growth, which remained relatively stable. Manufacturing employment had stabilized after steadily declining through the second half of 1998, and purchasing managers' surveys from across the District suggest that worker demand from the manufacturing sector remained relatively strong in July. There were a few new reports of increased turnover rates as skilled workers were being lured away by higher salaries offered by competitors. Contacts noted that starting wages for recent college graduates with accounting and/or technical skills, as well as some entry-level positions, were up significantly from last year. Another, however, noted slackening demand for technical staff as some Y2K concerns have been resolved. Contacts in many areas indicated that worker shortages continued to hamper business and production expansion plans.
Corn and soybean crop conditions were good, but hot, dry weather in Indiana, Illinois, and southern Iowa reduced soil moisture levels, causing crop condition ratings to decline in the second half of July. The hot weather, however, helped move crop development along more quickly than usual, keeping corn and soybean prices under downward pressure due to the large anticipated fall harvest. Hog prices also remained weak, averaging well below farmers' costs of production. Preliminary results from a survey of agricultural bankers suggested that farmland values during the second quarter declined in Illinois and Iowa, but rose in Indiana, Michigan, and Wisconsin. A majority of these bankers indicated that the pace of farm loan repayments remained below that of a year earlier, while the number of requests for loan extensions and renewals rose.