Beige Book Report: Chicago
August 29, 2012
Economic activity in the Seventh District expanded at a moderate pace in July and early August, with the pace of growth once again slowing from the prior reporting period. Contacts reported heightened concern regarding the risks to the economic outlook, notably the U.S. fiscal situation and weaker growth in Europe and Asia. Business spending increased at a slower pace, while consumer spending growth picked up some. Growth in manufacturing production moderated further, while construction activity continued to slowly increase. Credit conditions were again slightly improved. Smaller anticipated corn and soybean harvests due to the ongoing drought pushed crop prices higher and raised the cost of feeding livestock, with some pass-through to wholesale prices already taking place.
Consumer Spending
The pace of growth in consumer spending increased slightly in July and early August due in large part to heavy discounting by retailers to clear inventory space for back-to-school items. Store traffic was similar to last year at this time; however, retail contacts noted that the recent increases in gas prices were leading to less discretionary spending. Sales of summer clothing and other seasonal items remained strong. Sales of big-ticket items such as furniture again were weak, although sales of electronics improved some. Auto sales were little changed from the prior reporting period and dealers reported that inventories were beginning to creep up.
Business Spending
Growth in business spending slowed from the prior reporting period. Inventories were generally reported to be at comfortable levels. However, retailers remained cautious in their back-to-school and holiday season ordering and manufacturers also expressed a desire to tightly manage their inventories. Capital expenditures on software and equipment were proceeding as planned, but contacts cited a greater degree of restraint in new spending projects. Labor market conditions were little changed on balance. Hiring remained selective in most industries, with demand comparatively stronger for skilled manufacturing and construction workers, information technology specialists, and engineers. Several manufacturers reported transitioning temporary employees into permanent positions, and a staffing firm reported an increase in demand from the manufacturing sector.
Construction and Real Estate
Construction activity continued to increase at a slow but steady pace in July and early August. Multi-family construction remained an area of strength, and residential single-family construction increased slightly. Homebuilders noted that credit was still tight for residential projects, with lenders continuing to require large equity commitments before extending financing. Demand for nonresidential construction also continued to gradually increase. Industrial building and highway projects rose further. Elevated office and retail vacancy rates remained a drag on new commercial construction, but contacts indicated that demand for office space was slowly improving. That said, a commercial real estate broker noted that companies lack the confidence to make long-term real estate commitments, as many continue to negotiate for contracts with opt-out provisions after two to three years into their lease agreements.
Manufacturing
Growth in manufacturing production slowed further over the course of July and early August, with contacts expecting this slower rate of growth to persist throughout the second half of the year. In the steel industry, capacity utilization fluctuated some during the reporting period, but was roughly unchanged on balance. Metals manufacturers noted continued volatility in their customers' orders, as many were closely monitoring their inventory levels. The auto industry continued to be a source of strength for manufacturing. Demand for heavy equipment also remained solid, with rental fleets continuing to expand. Manufacturers of household goods and building materials reported that activity had picked up some, although it remained at low levels. The coal mining industry, however, was a notable exception, as the low price of natural gas has resulted in the substitution of natural gas for coal in electricity production. Exporters noted weaker demand from Europe and Asia, but continued strength from other parts of the world like Mexico.
Banking and Finance
Credit conditions gradually improved over the reporting period. Credit spreads and volatility moved lower and increased competition led to downward pricing pressure on small business loans. Business loan demand continued to be mostly from small and middle market firms and for the purpose of refinancing existing debt as opposed to financing capital expenditures. Banking contacts reported that many of their customers are waiting to assess the impact of the upcoming election on tax and healthcare policies. Consumer loan demand was steady. Mortgage refinancing continued to increase and contacts noted the greater availability of sub-prime loans for used autos. With overall loan growth flattening out in recent months, a banking industry contact noted that some banks are investing in municipal bonds as a way to increase their earnings.
Prices and Costs
Cost pressures were mixed in July and early August. Prices fell for a number of commodities but rose for materials like steel and lumber. Gasoline prices moved higher and shipping costs were also noted to have risen. Retailers reported that the spike in agricultural commodity prices resulting from the drought, particularly its impact on higher feed costs, was already starting to be passed through to wholesale prices. Wage pressures continued to be moderate, although several contacts cited upward pressure on healthcare costs.
Agriculture
The drought has substantially reduced expected yields for corn and soybeans, although the impact varied considerably across the District. Scattered rains near the end of the reporting period helped revive soybeans to some degree; however, with the exception of some late-plantings, the precipitation was too late to improve yields for most of the corn crop. Crop insurance and higher prices will partially offset lost revenue. However, some farmers face the prospect of having to buy corn at market prices after selling ahead more than they will likely harvest. Livestock pastures are in poor shape as well, and fields with low corn yields were being chopped for silage to feed livestock. With feed costs high, livestock operations cannot cover their costs of production, and operators have reduced their herds accordingly. Hog and cattle prices were down from the prior reporting period, while dairy prices were up as milk production dipped.