March 5, 2008 Federal Reserve Districts Eleventh District--Dallas

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The Eleventh District economy continued to soften from January to late-February. Reports were uneven but suggested moderate economic growth. Contacts expressed a great deal of uncertainty about the outlook for growth, and some said they are preparing for the possibility of an economic downturn. Energy activity remained high, but the level of activity has flattened out. There was a pickup in service sector activity, but manufacturing continued to soften, and retail sales were weak. Construction activity slowed further. Financial service firms said lending had softened. Dry weather hampered agricultural conditions. Prices Costs are rising for most industries, particularly for metals, shipping and energy. Some firms said they've been able to pass higher costs onto customers, but many said competitive pressures have restrained selling price increases and profit margins. Strong global demand pushed up oil and natural gas prices. Gasoline prices began a sharp seasonal rise as the driving season approaches. Higher fuel costs have pushed up shipping fees, and one contact said a new fuel surcharge has been added for overseas cargo. Agricultural prices have also risen. Cotton prices are up, while wheat, corn and sorghum are near record levels. Food manufacturers said concerns about high electricity costs are dwarfed by escalating prices for flour, shortening, corn, soybean meal and dairy products. Contacts say they see no sign of upward price pressures abating. Building costs have risen for nonresidential construction. Metal prices are up, including for aluminum, copper and steel. Prices have fallen for lumber and other products used in residential construction. Labor Market A number of firms reported that they have reduced employment and/or frozen hiring to keep operations lean in preparation for the possibility of slower activity. Still, there are firms reporting that activity is being restrained by labor shortages, particularly for skilled workers, such as certified mechanics, engineers and those who support the energy industry. Upward wage pressures have eased in some industries but continue to be reported in others. Temporary service firms said pay rates have been pushed up because of shortages of white collar and executive talent. Shipping firms said the shortage of talent has pushed wages up by 5 percent. Manufacturing Factory production continued to soften. Demand for paper has been seasonally slow, and some producers fear that sales have been more sluggish that the typical seasonal slowdown. High-tech manufacturing activity has weakened, and firms said customers are reducing capital spending and inventories in anticipation of a possible downturn. Production of automobiles has weakened, but orders remained solid for manufacturers of boats, barges and aerospace components. Food producers said demand has not increased, which they attributed to high prices. Demand remained weak for materials to supply residential construction, such as lumber, metals, brick and glass. Contacts at these factories were pessimistic, and said business is tough and competitive. Sales of products for nonresidential construction are still strong but no longer offsetting slowing residential sales, and there is caution that activity will slow. Refiners cut production in the face of weak margins and high gasoline inventories. Utilization rates dropped sharply from 89 to 85 percent--twice the normal seasonal drop. Domestic demand for polyvinyl chloride remained weak, particularly for residential construction, although sales remained fairly strong for commercial and public construction. Polypropylene producers have reduced production to maintain prices in the face of weak demand. Base chemicals and plastics continue to pull back from the massive exports that occurred last fall. Retail Sales Retail sales were weak in January but improved some in February. Companies with national stores said Texas sales have recently decelerated faster in the state than in the nation but still remain stronger than in the rest of the country. Auto sales picked up since the last report, which dealers attributed to increased advertising and incentives. Services Temporary service firms reported an unexpected pickup in demand for direct hires. Orders were strongest for professional and technical workers in IT, engineering and oil-related services. Demand remained solid for workers to supply healthcare. There was an increase in orders from the financial services industry, with demand coming for mortgage refinancing and credit collections. Orders to supply manufacturing were sluggish. Shipping activity was unchanged on balance. Declines in the value of the dollar have stimulated exports, according to contacts, but the increase has not been enough to offset the decline in imports. Railroad activity remained strong, stimulated by shipments of chemicals and products to support nonresidential construction. Rail transport continued to decline for products to supply residential construction, and there was a slight decline in volumes for petroleum products. Airlines reported an increase in traffic and say bookings are holding up. Construction and Real Estate Housing markets remained weak. Existing home sales were slower than a year ago. New home sales have been lackluster. Cancellation rates have risen, and contacts are concerned that rising foreclosures will add to elevated home inventories. Builders noted that downward pressure on prices has led to tremendous incentives on finished speculative inventory. Industry contacts have become more pessimistic and now do not expect improvement until 2010. Apartment markets continued to improve with strong demand and rising rental rates. Commercial construction remained active, but demand for office and retail space had decelerated. The pace of investment in new nonresidential projects has slowed. Financial Services Financial service contacts have become much more cautious. Reductions in the federal funds rate have squeezed net interest margins at numerous small-to-midsize financial institutions where asset returns have declined more than the cost of funds. There is aggressive competition for deposits and good quality deals. Smaller institutions say it is tough to compete against aggressive loan repricing by larger financial intermediaries. Lending has softened, especially for automobile, mortgage and commercial real estate loans. Credit standards for commercial loans have tightened. Credit quality is sound, say financial service contacts. Energy U.S. and Texas drilling has been flat, leaving activity outside North America to be the driver for sales and revenue growth. New environmental regulations have raised costs and cut the level of activity in southern New Mexico. Drilling continued to decline in the Gulf of Mexico, as rigs leave for higher profits elsewhere. Day-rates for land rigs, pipe and other durables remain flat, while prices for drilling and evaluation services have flattened more recently. The entrance of new oil service and machinery firms has helped ease pricing in many areas, such as pressure pumping. Agriculture High prices and a large 2007 crop has boosted farm income and spurred investment in farm equipment. Recent dry weather has caused poor pasture conditions and led to concerns that wheat and oat crop yields could be below average. Still, livestock are in good condition, and contacts say rain can improve crop yield projections. Return to top Kansas City San Francisco