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The Seventh District economy continued its moderate expansion in June and July with no new reports of upward price pressures. Consumer spending picked up from our last report as weather conditions improved, with sales slightly exceeding most retailers' expectations. Commercial construction activity continued to increase and the residential market, while softer than last year, remained strong. Manufacturing activity picked up from a brief slowdown in the second quarter, due in part to settled auto-related strikes. Lending activity was very strong in June and July and asset quality was reportedly improving. Labor markets continued to tighten and a few new reports of upward wage pressures emerged, particularly in lower-paying and clerical occupations. Recent rains helped restore favorable conditions for most of the District's developing crops.
Retail Sales/Consumer Spending
Retail sales were described by most contacts as at or slightly above expectations over the last six weeks, and in line with their national averages. One large retailer said that no one particular product segment was doing exceptionally well or exceptionally poorly, a statement that seemed to sum up the sentiment of most other contacts. Sales of apparel, most notably women's, continued to outperform other items. A few merchants mentioned that sales of home items (big-ticket appliances, furniture, bedding, etc.) were picking up after a period of softening. According to contacts, sales of some luxury items, such as personal watercraft and all-terrain vehicles, were up noticeably over last year. Inventories were reportedly in line with most retailers' sales expectations, limiting the need for any new promotional activities. Profit margins continued to be squeezed and competition among stores remained intense. Since July is one of the slowest months for most merchants, many indicated that August sales results would be a harbinger of what is in store for the remainder of the year. One large national chain pointed out that there had been a noticeable shift recently from the use of store credit cards to third-party (Visa, MasterCard, etc.) cards. Most retailers noted that no new upward price pressures had cropped up in the last six weeks.
Housing/Construction
Overall construction activity remained robust in the District through June and early July. Commercial construction activity was, as in our last report, very strong with some areas experiencing record levels of activity. The strength was nearly universal across sub-sectors. Very low office vacancy rates in many areas were spurring new office development, the bulk of which was taking place in the suburbs. A Des Moines area contact pointed to owner-occupied development as a key source of strength in that office construction market. Another contact, in the Indianapolis area, reported the first "significant" new office building in eight to ten years. Development of light industrial and retail space continued to be strong as well. Activity in the residential real estate market, while mixed, remained strong. Construction of new homes was reportedly off 5 to 10 percent in most areas from very high levels one year ago. Building permits were down moderately from a year ago in four of the five District states, with only Iowa experiencing an increase. There were some reports of unintended inventory building and "informal" price discounting or incentives. With profit margins already squeezed and competition fierce, many builders were very reluctant to advertise discounts. Sales of existing homes picked up in June and were up moderately from a relatively soft June last year, when inclement weather hampered sales. Most realtors, however, noted that year-to-date sales levels continued to lag last year's results. Both realtors and builders expect that strong job markets and recent reductions in mortgage interest rates will keep the housing market strong through the end of the year.
Manufacturing
Manufacturing activity picked up in recent weeks after a brief slowdown in the second quarter. Many of the auto-related strikes, which contributed to that slowdown, have since been settled. A new strike, which was beginning to curtail a major automaker's production, was settled after less than a week and workers were back on the job at the time of this report. Virtually all manufacturing sectors reported increased production, strong orders, good inventories, flat prices, and high expectations. Automobile makers indicated that production had increased to the levels anticipated before scattered strikes affected output. Inventories were in very good shape, although one major producer reported a slight buildup in automobiles. Some manufacturers, however, were having difficulty keeping up with their dealers' demands for light trucks. Producers of heavy equipment, including agricultural equipment, reported strong gains in production and new orders, and inventories were mostly described as "lean". Sales of heavy trucks continued to be strong, boosting production and reducing inventories to low levels. One truck manufacturer reported difficulty in building inventories to keep them in line with higher sales. Contacts in the steel industry also reported increased production and strong orders. Prices of finished products remained flat across industry sectors with slight variations. Automobile manufacturers planned to increase slightly their use of incentives, while heavy truck makers were planning on reducing some discounts. Contacts continued to report flat to slightly lower raw materials prices.
Banking/Credit
Overall lending activity remained strong, remarkably similar to that noted in our last report. Much of the strength was, once again, on the business side where demand increased steadily. Most bankers reported that the asset quality of commercial loans continued to be exceptional and may even have improved recently. Fierce competition for C&I loans was putting pressure on pricing, but no contacts reported lowering standards to attract new loans. Lending activity on commercial real estate remained high and asset quality was generally described as excellent. One contact, however, expressed concern over a recent increase in the use of what he termed "imprudent" lending practices, such as zero-equity and non-recourse loans. Lending on the consumer side was mostly described as flat. Mortgage applications were generally down over the last six weeks. One large bank reported a noticeable increase in refinancing activity, but most indicated that rates would have to fall further before refinancing activity would pick up. Some contacts also reported increased home equity and second-mortgage lending activity. Credit card usage remained relatively flat and some banks noted that their efforts to tighten standards were paying off in the form of improved profitability.
Labor Markets
In a now familiar refrain, labor markets tightened further in the District and shortages in some occupations and areas persisted. The average unemployment rate fell below 4 percent and there were a few reports of labor shortages leading to production plan alterations. There were also a few new reports of intensifying wage pressures, most notably on the lower end of the pay scale and in clerical occupations. In addition, one automaker reportedly had to raise entry level wages one dollar an hour above the going rate to fill a large number of positions. Some retailers were experiencing difficulties in retaining help. One major retailer, in an effort to reduce turnover, had recently reduced the period of time that an employee had to be on the job in order to receive a benefits package, while others had to raise wages. The most severe shortages remained in the professional and technology/information occupations. The slowdown from last year's torrid pace in the housing industry had eased, but not eliminated, the shortage of construction workers in some areas, resulting in fewer project delays. Once again, contacts were careful to point out that upward price pressures remained under control.
Agriculture
Crop prices, while trending lower, fluctuated widely in recent weeks in reaction to the anticipated influence of changing weather patterns on growing crops. Favorable weather improved crop conditions in northern portions of the District during the first three weeks of July. But warm temperatures and dry soils in mid-July stressed crops in other areas, especially Illinois. Fairly abundant rains since then have helped to restore generally good conditions as the remaining bulk of the District's corn crop entered its critical pollination stage during the last 10 days of July.
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