District economy will continue to grow, but some slowing creeps in

The district economy continues to grow at midyear as predicted in early 1999, and the Minneapolis Fed's regional forecasting models foresee a growing economy through 2000. However, employment growth is slower than expected, agriculture performance is still weak and banks, while still healthy, may experience a fall-off in profits.

Home building provides boost, but employment growth will slow

Increased home building has erupted as a big surprise in the economy. Six months ago the model was showing a decline in authorized housing units for three states. Now, in all states authorizations are anticipated to exceed historic growth averages. Year-to-date housing units authorized were up 62 percent through April compared to a year ago in South Dakota, up 24 in North Dakota and up 22 percent in Minnesota.

Unlike home building, employment growth is predicted to finish slower in 1999 than the model suggested six months ago. In January the model expected a 2.9 percent increase in district nonfarm employment; now a 1.6 percent increase is predicted.

District nonfarm employment growth for the three-month period ending in May increased 1.2 percent in 1999 compared to 1998. Construction employment picked up 6.4 percent, although the sector comprises only 3 percent of district nonfarm employment. Employment in services and retail trade outpaced the district average while manufacturing employment slipped 0.6 percent, indicating that the composition of the labor market continues to shift away from manufacturing industries to service companies and retail stores. The model predicts that district nonfarm employment will pick up in 2000 compared to 1999 in most areas, except Montana and North Dakota.

Employers hiring new workers are competing with a shrinking labor pool. The district unemployment rate reached 3.1 percent in May, the same rate as a year earlier. The model anticipates district unemployment will decrease to 2.8 percent by year-end 1999, slightly higher than January's prediction of 2.6 percent, and is expected to drop to 2.5 by year-end 2000.

As the search for employees continues to prove difficult, district employers are boosting wages to attract quality workers. Average hourly earnings in manufacturing grew 3 percent in the three-month period ending in May compared to a year earlier, and higher than last year's 2.5 percent increase.

Despite strong economic growth and increases in wages, prices remain subdued with some increases in home prices. During the first quarter of 1999, housing prices grew over 5 percent in Minnesota, Montana and North Dakota, but remained level in Wisconsin and decreased slightly in South Dakota. Minneapolis/St. Paul's strong housing market pushed prices up 10 percent in April compared to a year earlier.

Low prices, changes in market have farmers worried

Forecasts for farm commodity prices remain dismal. In addition, government subsidies and other structural changes to the agriculture industry are making farmers' decisions more complicated.

Increased demand for U.S. agriculture products will balance an expected increase in supply of crops to keep prices close to this year's depressed levels. The strengthening of the Asian economies is likely to increase U.S. grain exports, while at home the use of farm products for energy production is expected to increase domestic demand. On the supply side, U.S. corn supplies are anticipated to increase by about 3 percent in 1999. U.S. soybean supplies for 1999-2000 may reach record levels, exceeding 3 billion bushels for the first time, and the second largest wheat inventories in the 1990s are predicted.

With the expected increases in supply matching or exceeding increases in demand, agriculture crop prices are projected to remain at or below their low 1998-99 levels, according to the U.S. Department of Agriculture (USDA).

Meanwhile, the demand for meat products remains stable, while the supply of meat products is mixed. According to the USDA, beef production is likely to decline 6 to 7 percent in 2000, while pork production in 2000 is forecast to be about 3 percent lower than the 19.3 billion pounds expected this year.

Because of anticipated reductions in the supply of beef, fed-cattle prices are expected to rise from the mid $60s per hundred pounds in 1999 to the lower $70s per hundred pounds in 2000. Hog prices should hold in the upper $30s per hundred pounds in 2000, little changed from 1999.

Not only does the outlook for prices have farmers worried, but they are also concerned about the continued impact of the 1996 farm bill, which established a seven-year transition period to ease farmers from the old subsidy regime to a market-oriented farm policy. This will force farmers to respond more to market forces than to government subsidies. In addition, farmers are uncertain about how much special aid they will receive from the federal government this year. The poor outlook is also reflected in the most recent agricultural lender survey.

There is some good news. New developments in genetics and farm production technologies will allow the farmer to produce more efficiently over the long term. In addition, price contracts and crop insurance are available to help farmers reduce their risk as a result of market disruptions and natural disasters.

Stellar bank profits may be challenged

Commercial banks registered another strong year in 1998. Profitability as measured by pretax return on average assets was 1.91 percent during 1998, down marginally from last year's record high of 1.95 percent. Strong asset quality, continued high levels of fee and service charge income, and low overhead expenses helped Ninth District banks continue the streak of robust performances witnessed over the past eight years.

However, there are challenges to banks' stellar record of profits. Bank profits have actually been declining since the middle of last year and fell to 1.76 percent during the first quarter of 1999, the lowest level since 1992. The downturn in profitability can be traced to a persistent tightening of banks' net interest margins (the spread between the interest rates at which banks borrow and lend) which have been falling steadily over the last two years. With overhead expenses near historic lows and growth in noninterest income starting to stall, bank profits are likely to come under additional pressure during the rest of the year.

The asset quality of district banks as measured by the level of defaulted and past-due loans still remains strong. Yet, there are also signs of potential weaknesses in certain areas. Losses on consumer loans, which constitute a relatively small percentage of the district's total loans, have been rising steadily and were 20 percent higher in the first quarter of 1999 when compared with last year's first quarter. Credit card loans showed significant deterioration during the first quarter with losses more than doubling to 3.4 percent of average credit card loans. Stress from the district's weakening agriculture sector is also beginning to affect banks, as past-due agriculture loans rose to their highest level since 1993.