Dallas: October 2003

Overall Eleventh District economic activity showed signs of slowly improving in September and early October. While reports were uneven in many sectors, there continues to be cautious optimism that the recovery is strengthening. Still, most companies indicated a reluctance to expand their payrolls without the certainty of a permanent pick-up in demand.

Manufacturing activity was improved, with some industries reporting increased sales and optimism. Signs of strengthening demand were also appearing in the service sector, although reports are mixed. Contacts say that retail sales are slowly and erratically improving. There was little change in the energy industry, financial services, or construction and real estate markets. Overall agricultural conditions remain in good shape despite some weather-related crop damage.

Prices
Overall price pressures were mixed. Overcapacity and weak demand has led to falling prices for paper and boxes, which are now at a 20-year low. Most energy prices were lower, but remain at fairly high levels. Crude oil prices fell steadily in September from $32 to $27 per barrel, adding back a dollar or so in late September after OPEC surprised the world with a cut in production. The production cut was equal to Iraq's current production, and many saw OPEC's action as making room for Iraq's return to OPEC. Crude inventories were about 10 percent below normal through much of the period, and held steady in the last couple of weeks despite a decline in refinery demand due to seasonal maintenance.

The blackout in the northeast knocked out six U.S. refineries or about 3 percent of U.S. production and caused a brief jump in wholesale gasoline prices. The loss of production came at a critical moment, with gasoline inventories about 6 percent below year-earlier levels and Labor Day looming as the biggest driving day of the year. The spot price rose from $.95 to $1.12, but has since fallen back to $.90 or below. Pump prices have fallen back as well. Heating oil prices have fallen steadily throughout the period, as inventories of distillates have returned to healthy, year-ago levels.

Natural gas prices softened in recent weeks from $5 per thousand cubic feet to $4.50, as larger than normal increases in inventory kept the industry on track to refill storage to normal levels by the start of the heating season on November 1. Consumption of natural gas continued to decline, and contacts believe natural gas is being diverted to storage. Most observers continue to see gas production capacity shrinking one to three percent this year. Petrochemical prices mostly fluctuated with feedstock costs. Plastic product prices were mixed, with polyethylene and polypropylene up because of increased demand, and polystyrene down due to weaker demand.

Some prices are higher. The high and rising cost of health insurance was mentioned by many industries, and was noted as one of many deterrents to hiring. Prices are higher for some food products despite steep competition because higher input costs are being passed along to consumers. Some manufacturers indicated concerns about the high cost of utilities. Steel producers say that selling prices are beginning to rise despite stiff competition.

Manufacturing
Manufacturing activity was mixed but optimism continued to improve for some firms. Sales have picked up for most construction-related products, including lumber, stone, brick and fabricated metals. Demand is slower, however, for primary metals and paper products. Demand for food products is unchanged and below the level of a year ago. Contacts attribute the weaker than normal demand to declining orders from restaurants. One contact explained that upscale restaurants were scaling back last year and now all are ordering less.

Many high-tech manufacturers reported that production, orders and sales have continued to grow at the good pace set in the second quarter. Demand was reported to be strongest from the Asian and U.S. markets. Inventories were reported to be very lean, as desired. Most respondents expect growth to continue at a good pace over the next six months with one respondent saying that for the first time in a long time his outlook is for "reasonable, sustainable growth."

Refiners' margins spiked along with wholesale prices for gasoline, but margins have fallen back along with price to some of the lowest levels of the year. The lower margins should lead refiners to schedule routine maintenance over the next few weeks, pulling about 3 percent of U.S. production off line at any given time.

Petrochemical producers reported little change in basic petrochemicals, as demand was slightly weaker, overcapacity persisted, and profits were weak. Basic chemical producers report losing export markets due to higher costs associated with high natural gas prices, making it difficult to judge domestic demand.

Services
Activity in the service sector continues to show signs of improvement but remains uneven. Demand gains for temporary staffing have been inconsistent, but contacts say the outlook is more optimistic and feel that intentions to hire are improving.

Transportation firms reported mixed activity. Airlines reported higher load factors but lower profits. Trucking firms reported slower activity. The rail industry reported a marked increase in shipments of grain (exports)--the result of good crop yields in the U.S. and poor harvests overseas.

Legal firms reported some improvement but with continued caution about the outlook. In the last month, contacts report a steady stream of litigation and bankruptcy work and a noticeable increase in transactional and venture capital work. Accounting firms also say activity increased in the past month, primarily for tax work but with some improvement on the transactional side.

Retail Sales
Retailers report signs of gradual improvement, but sales growth remains uneven. Some contacts said that there was a noticeable slowing of sales after the tax payments were spent. Others indicated some worsening of the indicators they use to measure the financial viability of consumers. Department stores noted improved sales of women's apparel. Competition remains stiff, and two large retailers report that selling prices are down about 2 percent from a year ago. Automobile sales remained soft and are mostly driven by incentives, rebates and low-cost financing.

Financial Services
Financial service contacts reported similar conditions to the last report. Contacts continued to report gradually improving attitudes and expectations, but only a moderate increase in lending activity because many potential borrowers remain cautious about going forward. Mortgage lending, including refinancing, remained strong, partly because borrowers rushed to close as rates edged upward. Most contacts expected this rush to slow by now, but say it is still pushing mortgage lending volumes up. Commercial and industrial lending is mildly positive. Interest and traffic is up but customers remain cautious and are still unwilling to pull the trigger. Mergers and acquisitions activity is also picking up leading to higher fee income. Larger banks with more ties to financial markets are experiencing growth in this area, which is positively impacting earnings. Contacts say that asset quality is stronger, and deposit growth continues to be strong

Construction and Real Estate
There was little change in construction and real estate markets. The single-family market recorded steady demand, with August sales of existing homes reaching record highs in several Texas markets. Single-family builders noted that while demand for new homes was still at good levels, more incentives were being offered to lure new buyers. Without a pickup in job growth, many builders don't expect the current pace of demand to be sustained.

The apartment market remained weak. Properties that were in the pipeline before the downturn are still being built, and demand is low. Occupancy rates are flat to down, and rent concessions continued. Contacts in the office market noted increased "activity" but said it was mostly due to local companies re-negotiating leases or moving to new space within a city. Any significant improvement in the office market will depend on a markedly improved job picture, according to contacts.

Energy
The energy industry reported little change from the last Beige Book. Domestic demand has flattened out in recent months along with the U.S. rig count and remained flat in recent weeks. Contacts say the level of activity is high but disappointing compared to expectations of earlier this year. Exploration expenditures are up 33 percent this year over last, but they continue to be weaker than might be expected with the current price of oil and natural gas. Drilling in the Gulf of Mexico, a critical area for U.S. gas supplies, has remained near 100 working rigs or near the low of the last drilling downturn. International activity continues to improve slowly, providing good revenues for U.S. producers and service companies.

Agriculture
Harsh weather dramatically reduced the cotton crop in some parts of Texas. Recent cooler weather and rains have improved topsoil conditions for some remaining row crops and pastures, however. Vegetable producers in South Texas reported that heavy rains had delayed fall planting. Pasture conditions for livestock have improved in recent weeks. In addition, cattle producers are enjoying record high prices, which should result in increased profitability this year.