November 26, 2003

Eleventh District economic activity continued to improve slowly in October and the first half of November. Many contacts expressed more optimism about the outlook relative to six weeks ago. However, most contacts remain cautious and say they are reluctant to increase employment or make investments until the persistence of the recovery is more certain. Still, it appears that some are laying plans in preparation for prospective investment and hiring in the first half of 2004.

The service sector continues to strengthen, while manufacturing activity is recovering more slowly. Retail sales growth continues to be uneven but is showing signs of strengthening. Construction and real estate markets were mostly unchanged over the past six weeks. There has also been little change in energy activity or in the condition of the financial services industry. High prices and strong demand are boosting district agriculture.

Prices
Overall price pressures remain mixed. Energy prices have been volatile. Contacts say inventories are generally considered ample for oil and oil products, and prices are trending downward. Natural gas prices are elevated relative to that of oil despite fairly ample inventories. Prices for petrochemicals and plastics generally remain linked to changes in the price of oil and natural gas feedstock. Most manufacturers indicate no change in price pressures. Prices are up for primary metals but continue to decline for apparel. Retailers continue to report that they have no pricing power.

Labor Market
Labor markets are still slack but there are signs of pending improvement. Layoffs have slowed. There are scattered indications of hiring and reports of rising wages. Insurance, particularly health insurance, remains a widespread cost concern, and a few contacts have suggested that these costs are adding to the reluctance to add new workers.

Manufacturing
Orders for high tech manufactured products continue to grow at a moderate to strong pace. Contacts note that there is still a lot of skepticism about the durability of the recovery, but one respondent said that about 20 percent of the industry is growing quite fast. Computers and telecommunications equipment were reported to be growing particularly well. Job growth continues to be slowed by productivity growth and outsourcing.

Increased mining and drilling activity has stimulated demand for fabricated metals, according to contacts, who say demand is up from a year ago. Still, activity is below expectations and inventories are higher than necessary. Demand for primary metals has remained stable and inventories are in good shape. Manufacturers of stone, clay, and glass report continued solid business, with October deliveries higher than in September. Demand for lumber products is seasonally slower, and inventories are "on the heavy side" in part because customers are keeping their inventories as thin as possible. Demand for paper products has been flat over the past couple of months, which is weaker than was expected. Demand for apparel and food products has been mostly unchanged over the past six weeks.

Refiners cut back production seasonally in October, performing maintenance and switching production from gasoline to heating oil. Demand for petrochemicals picked up temporarily in September, which most contacts attribute to inventory rebuilding. The surge ended in October when demand growth fell back, returning producers to overcapacity and weak pricing power. One contact expects weak conditions to continue until 2006.

Services
Transportation activity has increased. The airline industry is picking up from a very low base, with increased bookings, load factors and yields. Rail shipments also continue to show strength. Contacts plan to add more people and equipment, but rail capacity will be a limiting factor. The trucking industry is less optimistic about the outlook because new rules for safety and security scheduled to go into effect in January are expected to raise prices and make it more difficult to hire drivers.

Demand for legal services remains unchanged overall, but contacts are more optimistic about future activity. Demand for litigation and bankruptcy work continues to be strong. There has been gradual improvement in corporate/transactional activity and "chatter" has begun about IPOs. Contacts say the potential of interest rate hikes has spurred some renewed real estate activity.

The accounting industry reports improving demand. The turmoil in the accounting industry is still stimulating business; regulatory work remains the strongest area. Merger and acquisition activity has picked up some, and confidence about future transactional work has improved. There is still not a lot of IPO activity, and the energy industry has provided less work than expected.

Demand for temporary staffing continues to be slow and steady, but contacts are more optimistic about opportunities that are "on the horizon." Light industrial and automotive manufacturing work has strengthened, but consumer manufacturing and call center activity remains weak. Demand for workers from medical product manufacturing and retail is more active than this time last year. Contacts say only a small percentage of call centers are moving operations overseas and they believe it "is not as big a play as the media makes it out to be."

Retail Sales
Retail sales reports are still uneven, but most contacts are becoming increasingly confident that sales growth is very slowly improving. Some retailers remain cautious because they believe that job growth is too weak for demand growth to be sustainable. Automobile sales remained weak and are expected to continue to "limp along."

Financial Services
Lending growth is slowly increasing, but competition remains stiff, keeping interest rates and net interest margins low. Contacts reported no change in asset quality. Refinancings have stopped almost completely, according to lenders; while new mortgage sales continue, contacts do not expect much growth in the near term. Consumer and auto lending remain the strongest categories. Commercial and industrial lending are about the same as the last survey, with increased traffic and interest but still not a large uptick in activity. Deposit growth continues to be above target, and contacts expect these conditions to hold in the near term.

Construction and Real Estate
Fundamentals remain soft for multifamily and office markets, but respondents are more optimistic about prospects for improvement in early 2004. Contacts say the multifamily market may have finally hit bottom, but rental rates continue to edge down, and concessions such as free rent are still the norm. Demand for office space is still lackluster, and vacancies are high, putting downward pressure on rents. Still contacts say they are more optimistic about prospects for the office market than they were a few weeks ago. Investment activity in the office market continues to swell, with a record amount of capital available.

Contacts were more guarded about their outlook for the single-family sector, citing concerns about the slow pace of job growth. Existing home sales are at good levels, but contacts are concerned about rising home inventories in several areas. Builders say demand for new homes is steady, but competition is rising, putting pressure on margins and profitability. While new home prices are unchanged, builders are offering homebuyers even more incentives.

Energy
The rig count has been roughly unchanged since May. There continues to be excess capacity in onshore rigs, which is keeping drilling costs competitive. In Texas, drilling remains mostly in the hands of independents, on land and at relatively shallow depths. The Gulf of Mexico remains a big missing element in the current drilling picture. For further development in the Gulf, producers need to drill in deeper water to find new formations, and gains are being slowed by longer lead times, financial risks, technological impediments and a lack of equipment. International drilling is picking up, but most of the activity is in the lower-risk regions. A number of liquified natural gas (LNG) projects are being developed overseas with an intent to sell the LNG for use in the United States.

Agriculture
Texas cotton production is below normal levels because bad weather in the summer and early fall damaged crops in the Southern High Plains. Cotton prices, however, are at the highest level in several years because global cotton supplies are tight and demand has picked up, particularly from China. Cattle prices also are high, leading to very active cattle markets over the past six weeks. The increase in beef prices has been fueled by a ban on Canadian livestock imports, as well as rising demand for beef and tight domestic cattle supplies. Some contacts expressed concern over the high prices, however, noting that the price levels are not sustainable. The price increase has pushed up ranchland values and enabled ranchers to pay down debt.