September 8, 2004 Federal Reserve Districts Seventh District--Chicago

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The Seventh District economy continued to expand in late July and August, albeit at a slightly slower pace. On balance, consumer spending appeared to soften somewhat during the period. Business spending continued to increase, but the pace of hiring slowed. Construction activity also decelerated somewhat, but remained robust. Manufacturing activity again expanded solidly. Overall lending activity was relatively soft, despite a slight pickup in residential mortgage applications. Persistently high energy and materials prices were the primary cost concerns among business contacts, but there was little to suggest that these higher costs had become embedded in inflationary expectations. The District's agricultural situation was mixed again, as crop conditions remained well above year-ago levels while most agricultural product prices declined. Consumer spending Contact reports were mixed but, on balance, suggested that consumer spending softened somewhat in late July and August. Most retailers indicated that sales results during the period fell short of their modest expectations, with the Midwest a little weaker than other regions. Back-to-school sales generally were described as lackluster and apparel sales continued to languish. Electronics and appliances were among the better performing sales categories. Retailers said that inventories were relatively lean, in line with their conservative sales expectations. District auto dealers suggested that light vehicle sales had been "fickle" recently, with no clear pattern or momentum. Light truck sales were said to be faring better than passenger car sales. Inventories were still high, even though many auto dealers had cut back orders earlier in the summer. Tourism and related spending remained flat in most of the region. In contrast, theater ticket sales were still brisk. Business spending Business spending continued to increase recently, although the pace of new hiring may have slowed somewhat. Reports generally indicated that capital spending for information technology (IT) and other equipment continued to increase moderately, but future spending plans were tempered by caution regarding the economic outlook. Contacts suggested that much of the recent spending was dedicated to replacing existing equipment rather than outright expansion. Business travel and advertising continued to rebound. Freight volumes were also rising again, and industry contacts said that capacity constraints were hindering freight movement in some areas. Many shipping firms, both rail and over-the-road, were boosting capital outlays and adding permanent workers. Manufacturers also appeared to be adding to their payrolls to keep up with production. More generally, however, permanent hiring was still subdued. Temporary help firms said that the number of workers on assignment remained above year-earlier levels, although growth rates had flattened out. With regard to seasonal help, contacts in tourist areas reported that summer help may be furloughed earlier than in previous years, while retailers indicated that hiring for the upcoming holiday season will be even with or lower than last year. Construction/real estate Overall construction and real estate activity remained robust in late July and August, although it may have softened slightly. Residential activity appeared to slow in some areas, though Realtors and builders said that home sales remained robust and their "salespeople weren't complaining." On the nonresidential side, office leasing activity was in a typical seasonal lull during August. Contacts also suggested that light industrial activity slowed in some areas. Rents in both segments remained under pressure as landlords were willing to "sacrifice rent for occupancy." By contrast, retail development and leasing activity remained brisk. Construction professionals from around the District have reported limited impact from shortages of some materials (such as cement) that have persisted in other regions of the nation. Manufacturing Manufacturing activity continued to expand solidly, boosted by strong demand for capital goods and materials. Producers of heavy machinery reported that production continued to increase and backlogs were up. New orders for heavy equipment remained firm, despite some recent softening. Manufacturers of heavy trucks also noted a "strong ramp-up in production," with one saying that increases in output were limited by shortages of some parts, including engines. New orders for heavy trucks recently backed off from "irrationally exuberant" levels, but remained robust. Strong demand for steel and gypsum wallboard continued, with both industries running near capacity. Steel inventories were up slightly, but remained lean. Many steel producers and service centers were reluctant to increase inventories further because they expected steel prices to fall from current lofty levels. Small manufacturing firms from a diverse set of industry groupings reported that new orders and production remained much higher than a year earlier. The active housing market continued to boost demand for home appliances. Light vehicle demand nationally was firm, but August sales were running slightly below manufacturers' expectations. Inventories were still elevated, but automakers had made only minor adjustments to their production schedules. Banking/finance Lenders generally reported a slight pickup in household loan activity, but persistent softness in business lending. Many bankers noted a slight increase in residential mortgage lending, a result they attributed to lower mortgage interest rates. However, applications for other types of household loans were flat. Standards and terms on household loans were largely unchanged and credit quality continued to improve. On balance, business loan volumes showed little, if any, increase. Many firms continued to use cash to meet their short-term liquidity needs, rather than borrowing. However, lenders also suggested that some firms had become more uncertain of economic activity going forward. Covenants on business loans changed little from our previous report, although some banks were reportedly lowering standards to "chase deals that don't exist" because of weak demand. Measures of business credit quality continued to improve. Prices/costs Higher oil prices were the primary cost concern for many businesses. Many contacts were concerned, disappointed, and surprised that energy costs had not yet retreated. Some firms (such as freight haulers) were able to pass along these higher costs in the form of surcharges and/or higher prices, while others (such as airlines) had less success doing so. Reports also suggested that oil prices were driving up the cost of plastics, rubber, and other petroleum-based materials. Firms continued to use surcharges to recoup the higher costs of steel, although outright price increases remained subdued. While higher energy and materials costs have persisted longer than expected, there was little evidence to suggest that they have become embedded in producers' inflationary expectations. Price increases at the retail level remained benign. Many retailers said that the pricing environment had actually become more competitive during the reporting period, and were expanding discounts to include more key merchandise. Wage increases were again subdued, but rising nonwage labor costs remained a concern for many employers. Agriculture Agricultural producers faced atypical weather patterns during the reporting period. Precipitation was scattered, although moisture levels were adequate in most of the District. In addition, unseasonably cool temperatures delayed crop growth and contributed to an increase in localized crop disease and pest problems. Overall, crop conditions deteriorated slightly, but remained much better than last year when there was significant late summer deterioration. Crop development and conditions continued to lag the norm in northern parts of the District, but were again better than normal in southern sections. A bumper harvest is still possible in some areas if seasonal temperatures prevail, but an average harvest is the best that other regions could experience. Prices of many agricultural products fell during the reporting period, including those for corn, soybeans, hogs, milk, and beef. Elevated energy prices have contributed to an increase in drying costs at grain elevators, adversely affecting farmers as the harvest approaches. Land values flattened in some parts of the District, while they increased more slowly in other portions. Return to top Atlanta St. Louis