U.S. Federal Reserve Beige Book: Chicago District (Text)

The following is the text of the Federal Reserve Board’s Seventh District-- Chicago.

SEVENTH DISTRICT--CHICAGO

Summary. Economic activity in the Seventh District expanded more slowly in July and August. Contacts expressed concern about the economic outlook, noting lower business and consumer confidence. Both consumer and business spending were little changed over the reporting period. Manufacturing production expanded at a slower pace, while construction decreased. Credit conditions tightened moderately. There was further pass-through of elevated commodity prices to prices downstream. Expectations for the corn and soybean harvests were trimmed due to hot and dry weather in most of the District.

Consumer spending. Consumer spending was little changed on balance from the previous reporting period. Retailers reported the back-to-school shopping season got off to a strong start. Consumers responded more than expected to the increase in early back-to-school promotions on items such as apparel, and expanded their purchases even on non-back-to-school items. Spending on luxury goods also increased in July, but slowed noticeably in early August. Contacts noted that rising uncertainty about the economic outlook and stock market volatility had led to a decline in consumer confidence, pointing to lower customer traffic in August. Vehicle sales edged up in July before leveling off in August. A contact in the auto industry reported that many consumers were still waiting for Japanese products to become more readily available before making a purchase decision. Spending on other consumer durables like furniture and appliances remained weak.

Business spending. Business spending continued at a slow, but steady, pace in July and August. Some manufacturers reported proceeding as planned with capital expenditures and labor force additions to alleviate pressures on capacity. In contrast, contacts mentioned that lower expectations for farm income had slowed purchases of farm equipment. Several contacts also noted closely watching inventory and staffing levels in the event that increases in uncertainty in the economic outlook and financial market volatility took a toll on demand. A retail contact indicated that holiday inventories will likely be higher this year because retailers had been very optimistic at the time the orders were made. Labor market conditions weakened, with hiring still slow and unemployment edging up in the District. In addition, a large staffing firm reported a decline in billable hours for staffing and professional services as well as fewer permanent placements.

Construction/real estate. Construction activity softened in July and August. Residential real estate conditions remained weak. There was little new single-family home construction during the reporting period. Builder showroom traffic declined, as contacts noted an inability to maintain the slight momentum they had seen early in the summer sales season. Nonresidential construction also fell overall. Public construction work slowed some and commercial construction remained low. In contrast, contacts noted continued strength in demand for industrial construction, particularly from the automotive sector, and a slight uptick in demand from the retail sector. Commercial real estate conditions were little changed, with vacancy rates steady and downward pressure on rents.

Manufacturing. Manufacturing production appeared to have settled down to a slower pace of expansion in August after experiencing some volatility in output during July. Demand for heavy equipment moderated from its robust pace during the first half of the year. However, contacts noted as reasons for its expected continued strength robust activity in the energy and mining sectors, pending regulatory emissions requirements, low dealer inventories, a lack of used equipment, and an aging rental fleet. Auto production increased in July before leveling off in August, as inventories returned to more comfortable levels. District automakers also reported no change in production plans, despite concerns about the recently slower gains in sales. Capacity utilization in the steel industry remained at a record high level, with order books solid and steel service center inventories still tight. Manufacturers of industrial metals cited a significant softening in orders for near-term delivery, but a pick-up in recent weeks in higher volume, longer-lead time orders. In contrast, shipments of household appliances and construction materials continued to decline.

Banking/finance. Credit conditions tightened moderately over the course of the reporting period. Volatility in financial markets increased dramatically in early August. Contacts cited S&P’s downgrade of the U.S. credit rating, increased concerns about a European sovereign debt default, and reduced expectations for growth in the second half of the year as reasons for the increase in volatility. Corporate funding costs moved higher as a flight to quality caused credit spreads to increase. Business loan demand fell, with bank contacts indicating that heightened uncertainty had led many customers to adopt a “wait-and-see” attitude. Private equity investment also slowed. On the supply side, the availability of commercial and industrial credit continued to improve both for large and small borrowers, with stiff competition for the highest quality customers. Some traditional real estate lenders were reportedly moving into the commercial and industrial market, increasing competition and further lowering the cost of capital for these borrowers. That said, contacts expressed concern that recently announced layoffs at several large commercial banks and declining bank stock prices do not bode well for future credit availability.

Prices/costs. Elevated commodity prices continued to put pressure on costs in July and August. While prices for industrial metals like copper and steel eased some, they are still elevated. In addition, several manufacturers reported extended material lead times, particularly for specialty metals. Energy prices also moved lower, but contacts indicated that these lower prices have not yet been reflected in reduced fuel surcharges. In contrast, food prices continued to rise. Manufacturers and retailers both indicated a high rate of pass- through to downstream prices. Wage pressures remained moderate, but a few contacts noted that wages were starting to increase.

Agriculture. Corn and soybean crop conditions declined markedly in the primary production areas of the District due to hot temperatures and a lack of precipitation during July and August. Reports that lower quality corn was being used to produce biofuel despite its higher production costs were indicative of just how low stocks have fallen. Cash prices for corn, soybeans, and wheat rose during the reporting period. Ethanol plants were pushing up the bidding for corn to be used in fall production. Hot weather stressed animals, lowering the output of meat and dairy products. Hog prices set nominal records, while milk and cattle prices moved up as well. Sale prices for farmland continued to move higher.

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