November 27, 2002 Federal Reserve Districts Third District - Philadelphia

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Business activity in the Third District appeared to be advancing marginally in November. Manufacturers reported modest increases in orders compared with October. Retail sales of general merchandise have picked up from last month and from last year, but auto sales fell in October and remained steady at the slower rate in early November. Residential building and home sales remain strong, as does mortgage lending, but bank lending other than mortgages has eased, and commercial real estate markets remain soft. The outlook in the Third District business community is positive, although there is a general feeling that economic growth is fragile and likely to remain so, especially as long as the international situation is uncertain. With respect to their own industries, business contacts generally expect moderate improvement. Manufacturers forecast increases in shipments and orders during the next six months, and they have scheduled increases in capital spending. Retailers expect slight year-over-year gains in sales for the holiday shopping period. Auto dealers expect sales to be steady near the current rate through the rest of the year. Residential builders forecast a continuing high rate of sales and construction activity. Bankers generally expect overall loan demand to remain flat, and commercial real estate agents see no signs of imminent improvement in commercial and industrial real estate markets. Manufacturing Third District manufacturers reported a steady rate of shipments and a modest increase in orders, on balance, in early November. However, conditions were mixed among the region's major manufacturing sectors. Companies that produce industrial equipment and machinery have seen increases in demand, and there have been gains among food processing companies and makers of petroleum products. Firms that manufacture building materials and components have seen some easing in demand compared with prior months, although actual levels of production remain fairly high. Producers of electrical equipment and basic metals continue to report weak demand for their products. Area manufacturers generally indicated that their inventories declined marginally in November compared with October. Most of the manufacturers contacted in November indicated that prices for both the inputs they use and the goods they manufacture were steady during the month, and many said that price competition in their industries remains strong. The region's manufacturers forecast improving business conditions over the next six months. Just over half of the firms surveyed in November expect increases in orders and shipments during the next six months, while only one in 10 anticipate decreases in orders and even fewer expect shipments to decline. Area manufacturers' capital spending plans call for increases, on balance, and the number of firms that have scheduled stepped-up expenditures has increased somewhat compared with recent months. Retail Third District retailers generally reported slight gains in sales in October compared with September and with October of last year. The modest upward trend in sales appeared to be continuing into November. Merchants said the onset of more seasonable weather helped sales of outerwear and that sales in most merchandise lines picked up as well. Shoppers continue to be cost conscious, according to store executives, preferring lower-priced and store-brands among basic product lines. Stores in the region have stepped up discounting in response to this buying behavior and in order to stimulate holiday shopping. Merchants generally reported that their inventories were at planned levels. Some stores had fallen behind in receiving merchandise as a result of the West Coast shipping disruption, but most of those were now fully stocked or nearly so. Most of the retailers contacted for this report expect the current slow year-over-year sales growth to extend through the holiday shopping period. But they cautioned that military action or terrorism, should it occur, would probably keep shoppers out of the stores, at least temporarily, even during the normally busy year-end season. Despite their continuing efforts to contain costs, many retailers said they will hire their usual complement of seasonal employees. Auto dealers reported a drop in sales in October. The slower pace appeared to be continuing in November, although the weekly sales rate was close to steady for most dealers. Dealers' inventories have increased, but most dealers expect to work them down if the sales rate remains level, as they expect it to, during the balance of the year. Finance Outstanding loan volume at Third District banks has edged down in recent weeks. Almost all of the banks contacted for this report said commercial and industrial loan totals have been flat as business firms continue to limit capital spending. Several bankers noted some deterioration in commercial loan quality as borrowing firms have not earned the revenues they had expected this year. According to bank lending officers, this has been particularly the case among manufacturers and retailers. Most of the banks contacted for this report indicated that consumer installment lending and credit card loan volume have eased recently, although a few noted recent growth in home equity lending. Residential mortgage lending continues to grow at area banks. Purchase mortgages have been expanding as a share of mortgage originations, but some bankers expect refinancings to increase in the wake of declining interest rates. Nearly all the banks surveyed reported compression in interest rate margins and reductions in deposit interest rates. Financial service companies have seen recent increases in sales of annuities as investors, especially retirees, look for higher returns while remaining reluctant to invest in equities. Bankers in the Third District expect overall lending to remain flat as both businesses and consumers limit their borrowing. Several bankers noted that lower interest rates are unlikely to prompt additional borrowing while the economic outlook remains uncertain and the possibility of armed conflict in the Middle East persists. Real Estate and Construction Third District commercial real estate markets remain soft, but the upward trend in vacancies has shown signs of easing. Recent surveys by area real estate firms indicated that vacancy rates in most markets increased around one-half percentage point in the third quarter, after several quarterly increases of 1 to 2 percentage points in 2001 and earlier this year. The office vacancy rate in the Philadelphia central business district was recently estimated at around 14 percent. The vacancy rate in most suburban markets remains higher, at around 20 percent. Although quoted rents have been fairly stable, effective rental rates have eased as landlords have offered more concessions to renters. Contacts in commercial real estate say that although market conditions are probably near bottom, a strong upturn is unlikely. A number of buildings currently under construction will become available in the next two quarters. Real estate contacts say the new space will tend to limit both rent increases and new construction unless business activity in the region picks up significantly. Residential real estate agents and home builders generally reported steady rates of sales in October and early November. Price appreciation continued to be strong in many parts of the region. Builders and real estate agents expect a seasonal slowing of sales around the holidays, but they expect the underlying sales pace to remain robust into next year. Builders reported backlogs sufficient to maintain current rates of construction through most of the first half of next year at existing developments, and they are planning to begin new projects as well. Return to top New York Cleveland