April 26, 2006 Federal Reserve Districts Eleventh District--Dallas

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Eleventh District economic activity continued to strengthen in March and the first half of April. The energy industry remains very strong, while activity continued to pick up in the manufacturing and service sectors. Construction and real estate activity accelerated, boosted by vigorous homebuilding and mounting commercial construction. Contacts in the financial services sector report little change overall. Agricultural conditions are poor. Prices Price pressures are expanding, fueled by rising costs. Prices are up for utilities, gasoline and transportation. More contacts appear to be resigned that oil prices will be high for several months. While some industries still report that stiff competition is holding down selling price increases, there are increasingly reports of price increases from firms that had previously considered them impossible, both in the manufacturing and service sectors. Crude oil prices increased from near $60 per barrel in early March to over $70 in mid-April. Heavy maintenance at refineries reduced demand for crude putting downward pressure on prices, but this was offset by international tensions in oil-exporting countries like Nigeria and Iran. Oil inventories have built to very high levels, well above any recent history, presumably as a precaution. Gasoline prices increased 25 cents per gallon at the pump during the period, pushed up by strong demand, rising crude prices and shortages of ethanol, an additive that is being used in the transition to low-sulfur, non-MTBE gasoline. Diesel prices increased 10 cents at the pump. Natural gas prices remained near $7 per thousand cubic feet, held down by heavy inventories, which are now more than 60 percent above normal and well above the 5-year maximum. Labor Market The labor market continues to tighten. Reports of hiring have increased from both manufacturing and service firms. Contacts still note shortages of skilled workers, and there are more reports of a tightening of the market for unskilled workers. In some areas of the District, there are reports of difficultly finding workers who meet basic qualifications of employment, such as background checks and drug tests. The labor market is particularly tight in the portions of the District that had received an influx of residents who relocated following the hurricanes. Wage pressures are building for some industries, stiff competition is limiting profitability and the ability of firms to raise salaries. However, an increasing number of industries report that they must and are increasing salaries to obtain and retain workers. Manufacturing Overall manufacturing activity was strong and picked up slightly. Activity is strongest among producers supplying the energy and construction sectors. A number of manufacturers reported raising selling prices, including those in the apparel industry. Demand remained strong for construction-related products, such as lumber, fabricated metals, stone, clay and glass; and capacity constraints were limiting some production. Apparel producers report an increase in demand, and sales of food products is up slightly. High-tech manufacturers reported good, steady growth in sales and orders. Respondents say most of the output gains are coming from continued strong productivity growth rather than hiring. Inventories are at desired levels. Prices are not declining as fast as normal, they say, and profits are increasing. Petrochemical production is weaker than a year ago. Prices fell for most petrochemical products, but some prices still remain above where they were prior to the hurricanes. Stronger prices in the United States than in other parts of the world are attracting petrochemical imports. With increased imports and relatively low prices abroad, domestic producers of petrochemicals are finding smaller markets for their products. The industry continues to recover from the hurricanes, with some plants just now coming back on line. Some producers are going through an extensive maintenance that was postponed by the hurricanes, and this is affecting the ethylene market, in particular. Refiners also had a long maintenance season, and refinery utilization rates have been low. Inventories of raw gasoline are at 5-year highs, but refiners lack sufficient quantities of the additive ethanol that is now required in most gasoline sold in the United States from late spring to early fall. Refined product imports have settled back to historical ranges, after soaring to as high as 5 million barrels per day after the hurricanes. Services Demand for business services remains strong, and several firms report increased activity compared with last year. Temporary service firms report good demand, particularly for high tech and light industrial manufacturing workers. Legal firms report steady demand overall. Real estate, transactional and corporate work remains robust, but litigation activity is down. Accounting firms say activity is still strong especially for audit services; however, demand for Sarbanes-Oxley related work has slowed. Demand for transportation services remains strong and up significantly compared with last year. Railroads are planning to build additional rail lines to increase capacity. Trucking firms continue to report difficulty finding qualified drivers. Demand for air travel is strong, and contacts say forward bookings look good. Airlines report that reduced domestic capacity has increased load factors and that, along with rising fares, is helping them keep up with soaring fuel costs. Retail Sales Retailers report good sales growth, but year over year comparisons have been complicated by Easter's shift from March in 2005 to April in 2006. Sales are weakest to low-income consumers for who, contacts suggest, are paying a larger share of disposable spending to high utilities and gasoline costs. One large retailer noted a recent deterioration in credit portfolios and spike in delinquencies, suggesting that some customers are unable to pay all of their bills. Contacts say that competition in the industry remains stiff, but there is "some pricing authority," which has permitted price increases or fewer discounts. Product costs are also rising. Auto dealers report flat demand and very slow sales for cars and trucks made by American-owned companies. Inventories are very heavy for some vehicles, pressuring dealers to lower prices and bring back rebates for those models. Construction and Real Estate Residential markets remained strong. Homebuilders reported record setting sales for the first three months of 2006. Demand for existing homes was also strong. Single-family home markets are extremely competitive, however, and builders say they are reluctant to increase prices, even as construction costs have risen. Contacts remain concerned about news reports of slowing home markets nationwide but seem more confident than at the time of the last Beige Book that local markets will be unaffected. Builders in Dallas/Fort Worth are keeping their eyes on higher inventories. Contacts are seeing some increased investor activity, but say the price gains appear driven by economic fundamentals. Apartment leasing continues to increase, and contacts say demand is stronger than usual for this time of year. Inventories remain at good levels with only moderate construction planned for this year. An exception is San Antonio, where contacts are concerned that there may be too much building. Apartment rents are up in Houston, but rents are not firming as much as expected in Dallas/Fort Worth and Austin. Commercial construction activity is strengthening. Demand for retail space is strong in all the major metropolitan areas. Office and industrial occupancy continues to rise, which is spurring construction activity. Houston will see a good bit of construction this year, with several new industrial development projects underway near the Port of Houston and strong demand for professional and medical office space. Dallas office demand has picked up, say contacts, with some suburban sectors nearing full occupancy, according to contacts. However, downtown Dallas continues to have ample vacant space. Contacts expect commercial construction to be especially strong in Austin. Financial Services Financial services respondents continue to report fierce competition for loans. While there have been some increase in home mortgage delinquencies, contacts say overall loan quality is very good. Short-term interest rate increases have not adversely affected clients nor slowed loan demand. Respondents would prefer stronger growth in deposits, which has been flat. Energy The oil services industry reported that demand is still very strong, and capacity is tight, with growing backlogs, and an increasing rejection of work that cannot be scheduled. The rig count continues to rise over the past six weeks, with the number of working oil and natural gas rigs up by over 50 in Texas and by over 80 in the United States. The growing rig count owes to new rigs entering the market and some refurbished and rebuilt rigs. Also, the Gulf of Mexico returned to over 90 working rigs--near the levels before the hurricanes. Rigs continue to leave the Gulf, however, and the day-rates in the Gulf have picked up very sharply since the hurricanes. Agriculture Wildfires and continued dry weather have led to a deterioration in agricultural conditions. About 10,000 head of cattle and over 800,000 acres of land were lost to wildfires in March. Ranchers are heavily culling their herds in the driest regions of the District, and supplemental feeding remained necessary. Contacts say wheat and oat crops are in poor condition, and more than half of the planted wheat crop is expected to be lost. Recent rains have improved planting conditions and spurred land preparation for spring planting in East and Central Texas, but overall moisture levels were still below average. Crop insurance may be the only way that some producers can cover their costs, according to contacts, who say that dry conditions and high energy costs are making the production outlook uncertain. Even with insurance program payments, agricultural lenders expressed concerns that statewide credit quality conditions may deteriorate in the second half of the year. Return to top Kansas City San Francisco