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Beige Book Report: Chicago

March 3, 2004

Reports indicated that the pace of expansion in the Seventh District economy picked up somewhat in January and early February, largely reflecting improvements in manufacturing. A broader array of manufacturers said that new orders and shipments were up during the period, and inventories remained lean. Contacts suggested that both consumer and business spending picked up, though hiring was again subdued. Construction and real estate activity also rose somewhat. Loan volumes increased slightly and overall credit quality improved. Retail price increases remained subdued, though costs and prices were reportedly increasing for many manufacturers. Reports from agricultural contacts were more upbeat, in part reflecting the higher prices being received for corn, soybeans, and milk.

Consumer spending
Contact reports were mixed, but generally suggested that consumer spending rose slightly in January and February. However, some national retailers said that sales gains in the Midwest were still weaker than their national averages. Merchants reported that sales were strongest for deeply discounted items. Contacts in casual dining indicated that sales picked up across restaurant segments in January and February. By contrast, District auto dealers reported that light vehicle sales slowed from December to January and remained soft into February. Light vehicle inventories were said to be on the "high side" and many dealers remained cautious in placing new orders. However, some dealers said that wintry weather contributed to higher service and body shop revenues. Heavier snowfalls also helped boost tourism in parts of the region. Looking ahead, most retail contacts expressed optimism that consumer fundamentals are in place for stronger sales growth later in the year.

Business spending
Business spending picked up modestly again in January and early February. However, firms remained somewhat cautious regarding their capital spending and hiring plans. Many firms reported that capital spending increases would be modest during the first quarter. A contact with one large IT firm said that many CIOs were planning to increase spending on storage, sales automation, and security software. Staffing firms reported that new orders for temporary workers continued to trend up modestly. Moreover, one large temporary help firm indicated that the average number of hours per assignment had surpassed its previous record high and was still rising. On balance, permanent hiring remained relatively subdued. There were some new reports of hiring by manufacturers, but the gains were largely offset by new layoff announcements. There were, however, more frequent reports of small businesses adding one or two workers to their permanent payrolls. With regard to both capital spending and hiring, much of the activity was geared toward replacement, rather than expansion. Contacts reiterated that competition remains intense and, as a result, many firms are focused on maintaining margins and market share, rather than "growing the business."

Construction/real estate
Reports indicated that overall construction and real estate activity edged up in January and early February. Sales of both new and existing homes were said to be strengthening somewhat as long-term mortgage interest rates declined. Some contacts suggested that the potential for higher mortgage interest rates later in the year prompted some "fence-sitters" to jump into the market in recent weeks. Homebuilders indicated that model traffic was strong, providing them with "high-quality leads." Inventories of existing homes for sale remained low, and home price appreciation was described as still healthy in most areas. Conditions in most nonresidential markets changed little from our previous report as vacancies remained elevated and asking rents were still under downward pressure. A few contacts noted a seasonal uptick in office property showings and inquiries, but it had yet to lead to a discernible increase in leasing activity. One contact reported that lease-termination deals had subsided modestly since the fourth quarter of 2003, suggesting that a recovery in office markets may be drawing nearer.

Manufacturing
District manufacturers reported solid gains in activity since the beginning of the year. A wide array of manufacturers said that shipments were up, new orders were strong, and inventories were still lean. One steel contact said that the industry was experiencing the strongest boom in 30 years as domestic demand for steel products remained robust and demand from foreigners picked up. Orders and shipments of heavy trucks strengthened further early this year, due in large part to increasing freight shipments and an aging tractor fleet. New orders for agricultural equipment were up sharply in January, according to industry contacts, while demand for heavy construction equipment remained strong. Machine toolmakers, primarily smaller niche producers, noted that new orders continued to rise, leading some to boost workers' hours or hire more temporary workers. One toolmaker said that the volume of price inquiries was "amazing," a phenomenon he attributed to a weaker dollar. After several years of strong sales, automakers were expecting light vehicle demand to be relatively flat in 2004.

Banking/finance
On balance, overall lending activity increased slightly in January and early February. On the household side, a large bank reported that credit card volumes were up slightly. Many bankers said that mortgage applications also rose somewhat from relatively soft levels toward the end of 2003. Lenders noted that declining mortgage interest rates spurred some new refinancing activity and helped keep new originations strong. One banker said that mortgage loan margins continued to narrow with a "huge mortgage underwriting infrastructure" competing for a dwindling pool of potential borrowers. Overall consumer credit quality was said to be improving, and some banks were reportedly loosening up on their standards. On balance, business loan volumes were still flat, although demand for small business loans continued to edge up. A few lenders pointed out that a good deal of the demand from commercial borrowers appeared to be for funding acquisitions, rather than for net expansion. Some contacts indicated that more firms were applying for lines of credit, but those lines were going largely unused. Business credit quality improved further from our previous report, while some lenders were loosening standards on business loans.

Prices/costs
Retail price increases generally remained subdued, but input and output prices appeared to be rising in manufacturing. Overall, retailers continued to rely heavily on promotions, although some were said to be cutting back on price discounts. Manufacturers in a variety of industries reported modest price gains or less discounting for their products. One steel producer said that prices for a wide range of steel products, which have been rising rapidly since the second quarter of 2003, will continue to increase sharply in the near term. The price increases are being driven by higher demand, notably from China. This also had led to some materials shortages (for scrap, coke, and iron ore) and industry capacity constraints. More generally, many manufacturers continued to express concern over rising natural gas and materials costs. Overseas shipping costs were also reported to be under pressure due to a shortage of ocean freight capacity. Wage gains remained relatively subdued while benefits costs, particularly for health insurance, continued to rise.

Agriculture
Agricultural contacts generally reported improved conditions in January and early February, with one noting that "coffee shop talk is definitely upbeat." Higher corn and soybean prices have boosted income from crops in most areas of the District. Many farmers continued to store crops in anticipation of future price increases. Dairy farmers' prospects also improved, as lower national production started to push up milk prices. The livestock sector, however, continued to deal with the fallout from the "mad cow" incident. Beef prices have drifted lower, in large part due to some nations' continued ban on beef imports from the U.S. Furthermore, feed costs were rising due to new regulations for cattle feed and higher crop prices. Land values and cash rents of agricultural land moved higher once again. Eastern portions of the District were reported to have excellent moisture levels for planting, while western portions needed considerably more moisture.