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The Seventh District economy continued to expand moderately in January and February, while reports of intensifying pressure on wages and prices were isolated. Confident consumers buoyed retail spending, with contacts reporting strong sales of electronics, home-related items, and light vehicles. Business construction remained robust, and sales of both new and existing homes were stronger than expected. Overall manufacturing activity was paced by strength in light vehicle and steel production, but pockets of weakness persisted. Despite higher interest rates, lending activity remained brisk and credit quality was said to be improving. In a familiar refrain, labor markets were very tight, shortages of workers persisted, and there were a few new reports of intensifying wage pressures. District farmland values strengthened in late 1999 and were up 1 percent for the year.
Retail sales in the District remained robust in January and February, with most contacts citing very high consumer confidence as the primary contributing factor. Virtually all of our retail contacts reported year-over-year sales gains in the mid-single digits, right in line with their expectations. Valentine's Day promotions were reported to be very successful. More generally, sales of appliances and home-related items remained strong according to most merchants, with one contact describing consumers' appetite for VCRs, DVD players, TVs, and game products as "insatiable." Inventories generally were in line with sales expectations, and promotional activity was similar to that in the same period last year. Light vehicle sales generally remained strong, although results varied by make and model. One contact noted that higher gasoline prices had not yet had much impact on demand for sport utility vehicles, which remains strong. A large auto dealer group reported that sales so far this year were down from a year ago, but had picked up in recent weeks and expects 2000 sales to be comparable to the very strong 1999 results. Another contact reported that sales of RVs and boats were very brisk. Despite continued strong demand for goods and services, reports of intensifying pressure on prices at the retail level remained isolated.
Construction and Real Estate
Construction and real estate activity in early 2000 was stronger than most builders and realtors had expected, given recent increases in mortgage interest rates. Sales results on the residential side were mixed. New and existing home sales in some areas remained softer than they had been last year, while other areas recorded exceptional growth. In the areas where sales were soft, contacts cited concerns about increasing interest rates; in the stronger areas, they suggested that confidence in the economy outweighed any effects from higher interest rates. However, traffic through homes for sale was reportedly strong, and none of our contacts expressed concerns about a significant falloff in sales. Commercial construction remained strong in most of the District, but growth reportedly had slowed. One exception was the Chicago area market, where development of office, retail, and multifamily residential space continued to rise steadily. Three new buildings in downtown Chicago will add 3.5 million square feet to the office inventory in the next two years, even as absorption rates have slowed. The additional space is expected to keep rents from increasing substantially.
Overall, strength in the manufacturing sector persisted early in 2000, although there was some softness in important industry segments. Resiliency in nationwide light vehicle sales kept both automakers and their suppliers operating at very high levels. Incentive spending remained high and inventories generally were still in line with sales. Strong demand for light vehicles and other consumer durable goods boosted steel production. An industry analyst indicated that steel consumption was at an all-time high with demand "dominated" by consumer-goods-producing industries. This contact also noted that inventory overhangs had been worked down and "no one even talk(ed) about them" recently. A District cabinet manufacturer reported that demand from homebuilders remained strong, and an office furniture maker said that demand was up substantially from the same period last year. Production of construction and agricultural equipment remained soft, while demand for heavy trucks was said to be slowing. Overall, the pricing environment was again soft for most manufacturers. The steel industry was one exception as previously announced price increases held, with another round of increases announced for April. Steel prices, however, were still below levels prior to the "Asian contagion" in 1997.
Banking and Finance
Overall loan demand remained robust as business lending continued to lead the way. Lending to households, however, was stronger than many bankers had anticipated. While home refinancing activity was again weak, home-equity lending picked up, and strength in new mortgage originations exceeded most lenders' expectations. Many contacts argued that increases in mortgage interest rates were being outweighed by overall confidence in the economy. Reports from bankers suggest a moderate improvement in consumer credit conditions. Business lending remained strong, with most evidence suggesting relatively steady volume growth. Overall asset quality remained good, with some contacts noting that they had seen more credit risk rating upgrades than downgrades. Most lenders continued to report that competition for business loans was keeping downward pressure on both spreads and fees. Bankers' expectations for overall lending activity in the next three months were mixed, with some expecting a moderate pickup and others anticipating a modest slowing.
The pattern of very tight labor markets and slow payroll employment growth over the last few years appeared to continue into early 2000. Labor markets remained much tighter than for the nation as a whole, and employers were struggling to find and retain workers. In efforts to keep turnover down, some retailers were paying bonuses to employees after the holiday season, and a fast-food chain was offering to pay for employees' textbooks. A few contacts in both goods- and service-producing industries indicated that product quality control was becoming more difficult as a result of the scarcity of adequately skilled workers. Overall wage pressures remained generally subdued, although there were a few exceptions. Wage increases for clerical workers were again cited by contacts, and one large freight hauler cited a survey that indicated nearly a third of truckload carrier drivers had received a wage increase of 4 cents a mile (or 15 percent) over the last three months.
District farmers benefited from an increase in hog prices, which were 30 percent higher in mid-February than a year earlier. However, large supplies continued to put downward pressure on corn, soybean, and milk prices. The Chicago Fed's quarterly survey of agricultural banks indicated that farmland values rose 2 percent, on average, in the District during the fourth quarter of 1999, with Illinois and Iowa posting their first quarter-to-quarter gains in nearly two years. Bankers indicated that farm loan repayments continued to come in slowly relative to a year earlier, but the average credit quality of farm loan portfolios was unchanged from a year earlier. Several bankers indicated the performance of their farm loans was enhanced by strong crop yields and federal assistance. Many stated they had tightened their credit standards for agricultural loans, and planned to increase their use of federal loan guarantees in the first quarter. Bankers also stated they believe the number of corn and soybean acres planted with seed containing genetically modified organisms (GMO) will be stable to declining this spring, relative to last year. Nearly 96 percent of the bankers expressed willingness to finance purchases of GMO seed.