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The Seventh District economy continued to expand at a modest pace in May and early June as reports of intensifying price pressures became more frequent. Sales of home-related items and light vehicles led strong consumer spending as consumers' resistance to price increases appeared to be softening. Construction activity continued very strong even as shortages of labor and some types of building materials slowed some projects. Manufacturing activity was robust with motor vehicles and construction-related industries running near capacity, while steel and agricultural equipment producers continued to struggle. Despite a sharp dropoff in home refinancings, overall lending activity remained strong. Labor markets were again tighter in the District than the nation as a whole, and reports of worker shortages and intensifying wage pressures became more widespread. Farmers were still having difficulty repaying bank loans due to low commodity prices. Corn planting in the District was nearly finished at the end of May while soybean planting was 80 percent completed.
Consumer Spending
Retailers indicated that sales results in May were in line with or slightly above their expectations, and a few contacts suggested that price discounting was not as big a factor in driving sales as it had been in recent months. Home-related items--furniture, lawn and garden, draperies, etc.--continued to receive a boost from exceptional housing activity. Apparel sales were also strong despite some weather-related softness in May. Discounters again appeared to fare better than general merchandisers, although sales growth had slowed somewhat from earlier in the year. A few retail chains with a national presence suggested that sales gains in the Midwest were not quite as strong as in the rest of the nation. One contact at a large auto dealer group in the District indicated that the market for light vehicles remained exceptionally strong, as consumers' confidence in the economy remained high. There were a few signs that consumers' resistance to price increases had softened slightly. Auto dealers and some casual dining establishments were able to push through very modest price increases; and a few retailers suggested that strong sales results were "not as price-driven" as earlier in the year, although a few merchants did continue using promotions to move some apparel items.
Construction and Real Estate
Construction activity remained very strong in the District, particularly on the commercial side. Office vacancy rates continued to tighten in most areas with some new development taking place, mainly in suburban areas. Demand for light industrial space, especially distribution centers, remained strong and development was reportedly keeping pace with that demand. The retail segment appeared to be the most vibrant of the commercial categories according to contacts, with "big-box" tenants driving the market. Sales of both new and existing homes continued to exceed most builders' and realtors' expectations, despite recent increases in mortgage interest rates. Many builders again expressed concern that severe shortages of labor were leading to project delays. Shortages of building materials, most notably wallboard, were not as acute in the Midwest as in other regions although there were scattered reports of rationing by suppliers. One major supplier to the construction industry noted that orders for trim (which is installed right after the wallboard) had not been cancelled or delayed, suggesting that shortages had not been causing significant delays yet. With exceptional strength in new home and commercial construction, however, this contact stated that severe wallboard shortages in the region were just a matter of time.
Manufacturing
Overall manufacturing activity remained robust in May, although softness in some major industries persisted. Appliance shipments, benefiting from the strong housing market, were well above last year's record levels through May. Noting that exports were down and imports up, one contact suggested that strong appliance sales were due almost entirely to exceptional domestic demand. This contact also noted that confident consumers were increasingly opting for higher-quality items, improving producers' profit margins. Automakers also pointed to consumer confidence as contributing to light vehicle sales in May that were the highest monthly results since December 1986. Heavy truck production was running near record levels as inventories remained very lean. One contact noted that demand for heavy trucks remained strong, although a slight softening in new orders had reduced backlogs from 12 months to about 9 months. According to this contact, a three- to four-month backlog is typical for the industry. Production at steel mills was again hampered by the inventory overhang noted in our last report, but one contact said that capacity usage at integrated mills was on the rise and prices were coming back a bit after declines earlier in the year.
Banking and Finance
Overall lending activity remained brisk in May and early June, despite some slowing in consumer lending. With mortgage interest rates trending upward in recent weeks, most bankers reported a noticeable and expected drop in refinancing applications. With home sales remaining strong, however, there was no significant drop in mortgage originations. One major bank noted that asset quality on consumer loans was improving as a result of the strong wave of refinancings earlier in the year and in response to some slight tightening of lending standards. Business lending activity was generally described as strong and steady, with little if any noticeable change in momentum. While there were some scattered problem segments (for example, loans to firms in the steel, agriculture, and energy industries), overall asset quality on commercial loans remained very good, according to most bankers. Competition for quality commercial loans remained intense, keeping margins narrow, and a few bankers noted that the industry had "taken a step back" by slightly lowering lending standards.
Labor Markets
The region's labor markets remained much tighter than the nation as a whole, intensifying pressure on wages and hampering businesses' expansion plans. Increased wages for information technology and administrative/clerical occupations were cited most often by contacts, but reports of broad-based wage pressures were more frequent than in our previous reports. One provider of temporary staffing services indicated that wages for administrative help had increased by 25 percent since the beginning of the year--costs that were passed along in large part to their customers. This firm was anticipating another price increase in June. Reports that severe shortages of labor were hampering economic growth also became more widespread since our last report. Builders and contractors suggested that shortages of qualified workers are more likely to cause project delays than the materials shortages noted earlier in this report. Contacts in metropolitan areas throughout the District reported that significant shortages of labor were limiting their ability to attract new businesses to their areas. A national survey showed that employers in the Midwest remained more optimistic about their hiring plans than their national counterparts and contacts at temporary help firms suggested that orders remain very strong with no signs of softening.
Agriculture
A recent survey of District agricultural bankers showed that farmland values during the three-month period ending April 1 rose in Michigan and Wisconsin, declined in Indiana, and were unchanged in Illinois and Iowa. On average, cash rental rates paid this spring were unchanged from a year earlier. Bankers reported that farm loan repayments slowed relative to last year as grain prices continued at low levels and milk prices fell. Hog prices increased to a near breakeven point for producers in early May but had retreated somewhat by early June. Corn planting in the District was all but finished by the end of May, while soybean planting was nearly 80 percent completed.
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