March 7, 2007

The Eleventh District economy continued to decelerate from early January to late February. Manufacturing and service sector activity grew more slowly. Retail sales picked up some. Nonresidential construction remained strong, but the housing market continued to weaken. Commercial lending remains solid, while consumer lending was still soft. Energy activity is robust, but contacts say the hectic pace has calmed. Agricultural conditions were mixed.

Prices
Energy prices fell in January but rebounded in February. Light sweet crude fell by more than $10 per barrel in the first half of January and bounced back to about $60 in February. Since the end of 2006, retail gasoline and diesel prices are down by 4 and 9 cents per gallon, respectively. Natural gas spot prices at Henry Hub weakened to $5.50 per million Btu early in the year but rebounded to between $8 and $9 for most of February. Cold weather reduced natural gas inventories, but they remain high at 10.8 percent above the five-year average.

Prices fell for a number of products, including lumber and petrochemicals. Prices fell sharply--as much as 20 percent--for many plastics. Polypropylene and polyethylene prices stabilized and rose by a few cents in February, but PVC (40 percent of which goes to pipe used in construction) continued to fall. Prices for bottle resins also remained weak because of seasonal weakness and new capacity coming on-line. Semiconductor prices declined, and home prices drifted lower in most markets. Auto dealers reported larger incentives.

Some prices were higher, such as for shipping. Legal fees are up. Office rents continue to rise according to contacts who also expressed concerns about higher utilities and taxes. Scrap steel prices have risen to an all-time high, boosted by strong global demand, and reduced import competition. Prices for other metals remain soft, however, and contacts expect price declines for copper and aluminum. Air carriers said expanding capacity is limiting fare increases.

Labor Market
Labor market conditions remain tight, with continued shortages for many types of workers, but there has been some softening. Hiring continues to increase at some firms, such as for nonresidential construction and food manufacturers, but the pace of hiring is slowing at other firms, and there have been some layoffs, such as for homebuilding.

There continue to be reports of shortages of skilled and semi-skilled workers, such as accountants, engineers and workers to support the energy, IT and nonresidential construction industries. Legal firms say hiring is increasingly competitive. The airline industry reports more difficulty finding and retaining qualified employees. Soft activity has improved the hiring picture for some professions. For example, auto dealers say the market for certified mechanics remains tight but not as bad as it has been over the past few years.

Wages continue to rise for workers in short supply. Several firms noted that they are preparing for increases in the minimum wage, with less concern about the first year increase than absorbing additional increases. Several industries continue to report high health care costs.

Manufacturing
Manufacturing activity continued to decelerate between early January and late February. Food producers continue to report stronger than expected demand, but most other industries reported softness. Paper producers report that sales of packaging materials have been flat.

Overall sales in the high-tech industry remain good, but there are reports of slowing sales for some products. Contacts say the demand picture has been clouded by stiff competition and changes in the mix of products bought by consumers. While sales to consumers are still strong, demand has been flat for automotive and computer products and weak for high-end cell phones. Sales have picked up for products sold to defense and industrial customers. Some contacts note higher than desired inventories, but contacts say industry inventories are still in good shape.

Demand remains soft for construction-related materials, such as lumber, stone, brick, glass, plastics and metals. Inventories are up for some products, leading some firms to cut production, reduce hiring or lay off workers. Contacts attribute weakness to unfavorable weather conditions and the continued slowing in residential construction. Demand remains strong to supply materials to nonresidential projects, such as office, retail, schools and public works. Some metal producers report weaker sales for nonresidential projects because budget overruns have led builders to "value-engineer" and substitute cheaper products.

Slowing housing construction has reduced demand for vinyl plastics and petrochemicals. Demand for auto-related products, such as tires, are holding at good levels. Some of the domestic slowdown has been offset by robust exports, which picked up late last year and remain very strong.

Gulf Coast refiners went into an extensive and extended maintenance season, with over a million barrels of capacity out of service on the Texas and Louisiana Gulf Coast in mid-January. Imports of gasoline have been relatively weak, and exports of diesel to Europe relatively high.

Services
Demand for business services continued to rise, although the rate of increase continued to decelerate. Temporary staffing agencies said demand remained soft for clerical and manufacturing workers, but orders are solid to supply accounting, IT and energy service firms. Accounting firms report increased activity and continued hiring. Demand for legal services is higher than a year ago, with increased activity in business transactions offsetting slow demand for litigation.

Container trade activity remained strong, but cargo volumes were down for shipping firms moving domestic small parcels. Trucking firms reported less activity which they attribute to a temporary decline in imports from China. Demand for air travel increased some over the past six weeks.

Retail Sales
Sales strengthened from early January to late-February. Retailers say sales are sensitive to changes in gasoline prices, particularly for lower income customers. Auto sales continued at roughly the same level as a year ago. Dealers say factory inventories remain high at many plants.

Construction and Real Estate
Housing markets continue to soften, and single-family construction is slowing. Demand remains weakest in the Dallas/Fort Worth area, where slowing sales and rising cancellations have boosted new home inventories to high levels. Respondents say negative housing news in other parts of the country has made buyers increasingly nervous, and some weakness is the result of investors pulling out.

Home demand is still relatively strong in other major metropolitan areas, although activity is slower than a year ago. Despite relatively strong new home sales, contacts say large national builders are reducing speculative inventory and construction (especially of lower priced homes), partly to free capital to manage their balance sheets.

Demand for nonresidential space remains strong. There continues to be a lot of construction of new office space in Dallas/Fort Worth, and activity is expected to increase in other areas, such as Houston and Austin. Contacts note a lot of apartments and condominiums are still under construction.

Financial Services
Financial service firms report solid commercial lending activity, with competitive pricing, but consumer lending activity remains soft. Credit quality is still strong, they say, but they are closely monitoring loan delinquency and default rates in real estate portfolios. Lenders continue to report difficulty attracting deposits, and say there is increased pressure to raise interest rates on these accounts.

Energy
Energy activity remains brisk, but the frenzy of activity has downshifted. Demand for oil services has slowed domestically but remains strong in most international markets. Service firms say order books are full, but new activity is no longer increasing at a rapid pace.

Domestic drilling remains at high levels but growth has been dampened by lower natural gas prices and higher costs, including rising wages and other costs. The U.S. rig count has been flat since August, and drilling for natural gas in Canada has recently dipped. Growth in the Texas rig count leveled off in late 2006, but drilling in the state increased in January and early February, boosted by the recent rebound in prices. Overall international drilling (primarily for oil) remains strong, and contacts say activity would be stronger with more available rigs, especially for offshore exploration. Additional offshore rigs are under construction and expected to be delivered this year and next, keeping activity strong for several years.

Agriculture
Unexpectedly cold weather delayed land preparation for spring crops but provided much needed chill hours for fruit, boosting the outlook for yields. Some areas received precipitation, improving soil moisture levels. Wheat and oat fields are in good conditions in these areas. Cold weather hurt pasture growth and livestock conditions. Cattle prices remain strong, but supplemental feeding has increased and grain prices are high. Contacts say that increased demand for ethanol has led to higher prices for corn and other crops.