September 2007

The Texas Economy: Strong Enough to Weather the Storm

Growth in Texas economic activity continues to cool as expected. Job gains remain quite strong and are still outperforming much of the rest of the country, but recent financial market turmoil has created additional headwinds for the economy.

Upward revisions to employment show the economy was even stronger than reported over the past year. Following stronger than average job growth of 3.4 percent in 2006, year-to-date employment has risen 2.7 percent—near the state's 35-year long-run average, and more than double the U.S. rate (Chart 1).

Texas employment increased at a robust annualized pace of 3.6 percent in July, but much of that was driven by a hefty 9 percent increase in government workers (Chart 2). Private employment rose a more moderate 2.5 percent. The construction sector has experienced a big swing in job growth this year from positive to negative. June construction employment was revised down from 3.1 percent to 0.2 percent. July construction employment fell 3.2 percent. The Texas manufacturing sector continues to outperform the nation's, adding 2,500 workers (up an annualized 0.5 percent) so far this year, compared with a loss of 98,000 U.S. jobs (–0.3 percent).

A recent repricing of risk by financial markets has led to reports of extreme financial stress at a few Texas firms, and a number of companies have announced employment freezes or layoffs related to the slowdown in mortgage lending and homebuilding. Despite the layoffs, the state labor market remains quite tight. The Texas unemployment rate increased to 4.4 percent in July, from 4.1 percent in June. The rate is still below its February level and below the U.S. rate of 4.6 percent. July initial claims for unemployment insurance declined to the lowest level of 2007.

Energy Activity Is Still Strong, but There Has Been Little Growth This Year
While robust, the level of Texas energy activity is showing signs of cooling. The Texas rig count has been flat over the summer. Well permits increased to 1,594 in July—the highest level since 1986. Still, there has been very little growth in permits over the summer.

Oil prices are high, but natural gas prices have fallen to near $6 per million Btu. Beige Book contacts expressed concern in August that the growing inventory of natural gas may push prices down to levels that will restrain some activity. Unconventional natural gas has been an important element of the current level of drilling, and high natural gas prices are required to justify this drilling. Recently, there have been reports of natural gas producers cutting back production in response to low natural gas prices and record high inventories.

Construction Continues to Cool
Texas residential real estate markets have been cooling for a year, and the reassessment of lending risk caused markets to decelerate slightly faster. According to Beige Book contacts, tighter credit standards curtailed some residential construction and commercial investment. Nonresidential activity is still at high levels.

Housing permits continue to fall and are down to the level of February 2005. Texas existing-home sales (six-month moving average) also continue to drift lower and are now at the level of April 2006 (Chart 3). Real median home prices have been mostly flat this year and are roughly even with the level seen in December. Texas existing-home inventories are just under six months—about at the level of mid-2005—and below U.S. levels (Chart 4). Still, a recent rise in new-home inventories in most major metropolitan areas has led some business contacts to express concern about potential weakness in home prices.

Outlook
Currently there is little evidence that the downturn in mortgage lending and homebuilding is feeding into the broader economy in Texas. Recent financial turmoil has increased uncertainty in the economic outlook and created more headwinds for the economy than expected, but Texas is in good shape to weather the storm.

The Dallas Fed Texas Leading Index increased in July. Most components of the index were positive between May and July. The index has been sluggish this year, suggesting slower employment growth than the brisk pace recorded last year. Employment growth is expected to come in at just under 3 percent in 2007. The probability of a Texas recession is less than 5 percent.

—Fiona Sigalla

About the Author Sigalla is an economist in the Research Department at the Federal Reserve Bank of Dallas. Note The employment data used in this analysis have been benchmarked by the Dallas Fed to first quarter 2007and seasonally adjusted by the Federal Reserve Bank of Dallas. For more information about early benchmarking data, see “Getting a Jump on Texas Employment Revisions,” Southwest Economy, November/December 2005.