December 1, 2004

Eleventh District economic activity appears to have accelerated slightly from mid-October to mid-November. Manufacturing and business service activity continued to slowly strengthen. Retail sales and construction were mixed. Financial institutions report continued improvement in conditions. Energy activity is up. Agricultural conditions remain mostly favorable. Many respondents noted relief that the election was over, explaining that it wasn't because one candidate won over another as much as the elimination of uncertainty.

Prices
There were many reports of higher prices but also reports of downward price pressures. Energy prices remain relatively high after spiking and then declining slightly. Higher costs for energy and other inputs remain a concern for most respondents. Some say they are increasing selling prices enough to make up for the cost increases. Others say competitive pressures, both domestic and international, are making that difficult. Contacts say import competition, particularly from China, is keeping downward price pressure on some manufactured products, such as apparel and fabricated metals.

After surging to near $56 per barrel on the spot market, crude prices dropped to slightly below those reported in the last Beige Book. Crude inventories are now near the five-year average level for November, helped by a surge of imports that had been delayed by Gulf Coast hurricanes. Private forecasts of a cold winter and spiking heating oil prices pushed spot natural gas prices to near $8 per million Btu in early November, but prices fell to near $7 per million Btu as natural gas storage rose to record levels.

With the possibility of stronger than normal seasonal demand for heating oil, contacts report concerns about heating oil production for the coming winter. Refiners have been in a significant turnaround period, and operating rates in October were below normal even for the fall maintenance season. Heating oil inventories have fallen to levels near the bottom of the five-year range. Heating oil prices have been whipsawed by uncertainty about the ability to refill inventories before winter arrives.

Selling prices are up for most chemical products. Producers say heavy demand is helping them pass along significant cost increases, primarily from energy, but also from shipping and other material inputs. Metals producers say selling prices are up slightly because of steep cost increases for aluminum, scrap metal, nickel and alloy.

Some producers express concerns about the effects of a weaker dollar, noting that increased costs for imported materials are pushing up prices for final products. Other contacts say they are not affected by changes in the value of the dollar because they do much of their transactions in dollars or in currencies that are pegged to the dollar.

Retailers anticipate the January 2005 elimination of import quotas for textiles to lower imported textile prices by as much as 13 percent to 18 percent. This reduction is expected to be reflected in prices for spring merchandise. Retailers do not expect to reduce selling prices. They say lower costs will translate into "more normal" profits and an improved quality of merchandise.

Labor Market
There are few reports of hiring or wage increases, although higher benefit costs, particularly for health care, remain a pervasive concern. Temporary service firms say they hope to push through higher fees to offset an increase in the Texas state unemployment insurance tax that they have been told is likely in January 2005.

Manufacturing
Manufacturing activity increased for most products. Demand was up for fabricated metals, high-tech, food and energy-related products. Sales remained strong for construction-related products, such as lumber, clay, cement, brick and glass, but contacts are cautious about slowing demand for housing.

Sales of primary metals declined slightly over the past couple of months, leading to a few shift reductions but no major layoffs. While contacts noted some continued effect from the hurricanes, they say there was also increased competition from Chinese imports. Sales of paper products have been lower than expected for this time of year, which contacts attribute to loss of market share to overseas producers.

Demand for food products increased some over the past month. Apparel producers say demand has been unchanged over the past month but is up from three months ago. Apparel manufacturers are very concerned about China's import quota ending next year.

High-tech manufacturers report that production and orders continue to grow at a good pace. Contacts say retailers have built inventories of IT products in expectations of healthy Christmas spending and there may be some shortages if sales are very strong.

Demand was up for energy-related manufacturers, including producers of oilfield hardware, tools and well-bore equipment, who reported higher prices, sales and margins. Demand for chemicals is extremely strong, particularly for products such as ethylene, polyethylene, polypropylene, polyvinyl chloride, chlorine, and caustic soda. Export demand for petrochemicals was very strong, based on favorable natural-gas-to-oil-price ratio, a weaker dollar, and significant operating problems in Europe and Venezuela. Refiners' margins have steadily improved in recent weeks, coming back from a significant decline in margins in late summer.

Services
Demand for temporary staffing firms picked up in most parts of the district. Demand strengthened for light industrial manufacturing, administrative and clerical work, according to contacts, but demand remained weak in the financial services sector. There were reports of temporary workers being made permanent, which contacts said was unusual for this time of the year.

Demand for legal services has been strong in the past month, and contacts say activity is up compared with a year ago. Accounting firms report that demand remains very strong and increasing, mostly due to the increased needs of the Sarbanes-Oxley Act. Accounting firms report substantial hiring, particularly for auditors and risk management professionals. Salaries for these types of professionals have increased by as much as 7 percent to 8 percent this year.

High fuel costs continue to plague transportation service firms. Railroads report high loads, particularly to carry metallic ores, metals, wood, building products and domestic consumer goods. The airline industry continues to suffer from too much capacity and no pricing power, forcing them to absorb all cost pressures. Contacts say that restructuring is being impaired by bankrupt carriers that continue to operate below total costs, pulling down healthier carriers.

Retail Sales
Sales growth increased for retailers selling to upper-and middle-income consumers, with particularly strong sales of high-end products, such as HDTVs and jewelry. Respondents attributed the increase in sales to lower gasoline prices, greater job security and reduced geopolitical concerns. Sales growth was "disappointing" for retailers selling to the lower-income consumers. Contacts say that these consumers are still feeling the strain of high gasoline prices and health care costs. Automobile sales remain soft, down slightly from year ago levels, with inventories higher than desired.

Construction and Real Estate
Housing sales and prices softened slightly over the past six weeks. Existing home sales tapered off, and homebuilders say traffic has slowed and they are offering more concessions. Many homebuilders report that sales are still above last year's levels, but inventories continue to rise. Housing industry contacts are optimistic for 2005, but say a stronger rate of job growth is needed to meet sales expectations.

The continued construction of new units is weighing down apartment markets in Dallas and Houston. Occupancy levels in Austin and San Antonio have improved, but contacts remain cautious about the outlook because of the amount of construction proposed and underway.

Office markets improved over the past six weeks. Respondents say leasing activity continued to pick up slowly. Existing tenants are expanding lease space, as companies and take advantage of low rental rates. Tremendous capital market activity continues. Office construction remains very low, with most being build-to-suit or government funded.

Financial Services
Deposit growth was flat to up. Commercial and industrial lending activity appears to be picking up, but contacts report that lingering uncertainty about the economy is still slowing some investment. Some contacts expressed concerns that higher interest rates are slowing lending, particularly to small business. Mortgage lending was flat to down.

Energy
U.S. crude oil demand has been near or slightly below what is expected for this time of year. The domestic rig count increased over the past six weeks, with most of the gains directed to oil. More land rigs are under construction, and some are being upgraded to support faster and deeper drilling. International drilling also rose in November, particularly in the North Sea. (Data show that international activity fell sharply in October, but contacts believe it was a statistical aberration because an unusual number of rigs were in transit instead of working.) Conditions in the oil field services and machinery sectors are improving, and most segments of the industry are busy and enjoying higher prices, growing backlogs of work and equipment orders, and expectations that their markets will remain strong.

Contacts report capacity constraints in some areas, but there appears to be potential for continued expansion in oilfield equipment manufacturing, oilfield construction and shallow offshore drilling. There have been some reports of short supplies of steel products in the oil patch—including drill pipe, downhole tubing, and anything made of stainless steel. Most respondents noted capacity constraints in labor-intensive oilfield services where people have to be especially well trained and qualified—such as fracturing, pressure pumping or tubular makeup. In addition, rental rates have improved for rigs capable of drilling deep water because many rigs were moved to other areas of the world that promised greater returns. The oilfield services that could not leave with the rigs--such as downhole fluids, supply boats, and helicopter services—are in excess supply.

Agriculture
Rain improved soil moisture conditions but halted planting and harvest in some areas. Supplemental feeding of livestock was active in the wet parts of the district. Estimates of Texas cotton production were revised up to 7.7 million bales, this will be an increase of 78 percent from 2003 and 27 percent from the record 1949 harvest. Strong U.S. production has pushed down prices for cotton, soybeans and corn. Contacts say demand is unchanged for most crops, but they hope that the weaker U.S. dollar may boost exports. Strong demand for calves and feeder cattle continue to boost cattle prices.