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Federal Reserve Districts

First District--Boston

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Business conditions in the First District continue to be mixed. Manufacturers generally report solid demand growth, except for housing-related items. Retail results continue to be varied. The consulting industry cites good revenue growth but some signs of caution among its U.S. customers. Residential real estate markets remain soft, while commercial real estate markets continue to improve on the rental side, but soften on the investment side, at least partly as a result of turmoil in credit markets. Contacts mention price increases for selected inputs. The outlook remains uncertain, but not downbeat.

Retail respondents in the First District cite mixed sales for the months of August and September. Same-store sales ranged from mid double-digit decreases to mid single-digit increases year-over-year. Health and beauty products, ladies' and juniors' apparel and accessories, televisions and small electronics were all among items that reportedly sold well. Sales of non-luxury cars continue to be down. Several retailers mention substantial increases in week-to-week volatility in sales.

Inventory levels are mixed, with several contacts reporting programs to reduce inventory. Headcounts are also mixed; some respondents report increasing headcount in line with company growth or seasonal hiring, while others report layoffs. Contacts cite price increases in metal-related products, chicken, beef, and dairy. Excess supply has kept lumber prices at record lows. Selling prices are generally stable, with a few companies passing small price increases along to consumers.

Retail respondents are cautious in their outlook. Most express concern about the current upheaval in financial markets as well as the potential impact on consumer sentiment; some respondents expect an economic slowdown and say they are uncertain whether it will turn into a recession, while others feel that it is not a matter of underlying economic weakness so much as consumer confidence. Several retailers anticipate no improvement for another one to two years. However, others remain optimistic in their outlook; as one noted, "for the right deal, people are still buying."

Manufacturing and Related Services
Manufacturers and related services providers headquartered in the First District report that third-quarter sales and orders have been mostly in line with prior trends. Demand continues to increase strongly for defense and aerospace products, biopharmaceuticals, health-related equipment, and various export items. Sales of housing-related products generally continue to run below year-earlier levels. Some contacts note recent sales blips (mostly downward, but some upward) for selected products, but they attribute them more often to temporary or idiosyncratic factors than to changes in the economy.

Most contacts describe materials and energy costs as rising somewhat or remaining stable at high levels. They express concern about actual or anticipated increases in prices paid for metals, nonmetallic minerals, rubber, energy, transportation, and corrugated cardboard. Most firms say that their average selling prices are up between 1 percent and 6 percent over year-earlier levels, and some plan to raise prices further in early 2008 in order to recoup higher materials costs. Respondents note that prices have eroded for some products, such as consumer electronics and automotive and industrial parts.

Contacts generally are adjusting their U.S. headcounts only minimally (up or down), and average wage and salary increases are remaining in the range of 3 percent to 4 percent. Manufacturers report that labor markets remain very tight for scientific, technical, and finance professionals, resulting in hiring delays and signing bonuses. Respondents mostly say that domestic capital spending is likely to be flat to up in coming months; only a couple indicate they recently scaled back their investment plans.

Most manufacturers and related services providers say they are either upbeat or at least reasonably positive about their business prospects. While citing continued weakness in housing and possible negative spillovers from tight credit, they point to export growth, new product development, and positive trends in their industry as reasons for expecting increased revenues in 2008.

Selected Business Services
A majority of contacted First District management consulting firms report that some of their U.S. customers have become more conservative. One firm cites increased renewals as a sign that companies are seeking more stability in their budgets; another indicates that its U.S. financial services clients are delaying purchasing decisions. Consulting contacts with a global footprint mostly report that demand continues to be robust. Pipeline activity is mixed; while the majority of contacts' backlogs are flat or up, a few are softer. Revenues are up between 5 percent and 20 percent year-over-year.

Several firms have put through modest price increases, while others have left bill rates unchanged. Input costs are relatively stable, although a few firms note rising rents. Headcounts are growing in response to demand, but at a slightly slower pace than revenues. Most respondents plan to increase wages by between 3 percent and 7 percent in 2008.

Business services respondents have a mixed outlook; those with softer incoming orders are cautious about the rest of the year, while others are more positive. However, firms with clients in the financial services industry say they expect that segment to have a tough fourth quarter.

Commercial Real Estate
As reported last time, credit conditions in the commercial real estate market have changed significantly in recent months. Contacts characterize the situation as a move to more "rational" or "conservative" financing, however, not a panic. Financing has shifted away from the Wall Street "conduit" market and toward banks and life insurance companies. Overall transactions volume is down sharply compared to a year ago. Borrowers with low loan-to-value ratios seeking to purchase prime commercial space with good cash flow are still able to get financing, albeit on stricter terms than previously, but speculative investment activity has been sharply curtailed by lack of financing. Contacts report some downward revisions to asking prices (on the order of 5 percent to 15 percent), but primarily for marginal properties such as vacant office buildings away from urban centers. Prime office and retail space continues to sell at strong prices due to a "flight to quality." Unfinished condominium developments (some with only 10 percent to 15 percent of units sold) are in very bad shape, however, and there is talk that some may convert to rental units to cut losses.

Rental rates for class A office space in Boston have remained high, but contacts predict slower rent increases moving forward, claiming some of the bargaining power has shifted back to tenants. Office vacancy rates remain in the single digits; absorption is positive but expected to slow in coming months. Rents are stable in the class B market, where vacancies are higher than for Class A space, but also stable or falling. Suburban Boston, most notably Waltham, continues to be in high demand among biotech and other industrial firms. In Hartford, rents for new industrial space outside downtown are also reported to be on the rise, but the rest of the Hartford market remains stable. Contacts say the industrial market has been "surprisingly strong" in Providence and northern Rhode Island, and office rents in downtown Providence are expected to continue to rise due to declining vacancies and strong job growth.

A risk moving forward is that projects in the planning stages, such as large mixed-use developments, may be delayed or shelved due to the unfavorable financing climate. Some respondents report that property valuations have changed and expect commercial real estate prices to fall even though not much softening has been observed yet. Contacts expect modest economic growth throughout the region, but some see a risk that hiring may become more conservative as managers wait to see what, if any, fallout may occur from financial market disturbances.

Residential Real Estate
Available reports on the Massachusetts residential real estate market are conflicting. Published data from the state realtors' group show increases in sales and median prices for both single-family homes and condominiums between August 2006 and August 2007. But more comprehensive August data (including foreclosure sales, for sale by owner, and new homes sold directly by the builder, as well as sales through realtors) give a more negative picture: According to these data, Massachusetts home sales decreased 1.5 percent as median prices dropped 4.9 percent year-over-year; in addition, condominium sales dropped 2.2 percent and median prices decreased 1.1 percent.

The other New England residential markets are mostly trending downward. Second quarter sales in Connecticut decreased compared to last year, although single-family home prices increased 10.7 percent, with the price increase concentrated among homes with four or more bedrooms. In New Hampshire, home sales declined 8 percent, and prices decreased 1 percent in August 2007 compared to August 2006. A Rhode Island contact also says that prices and sales are dropping.

Respondents express concern about the impact of negative housing-related news stories on buyers and about unrealistic pricing as sellers try to get more for their house than market conditions allow. In addition, contacts acknowledge that lending standards are tightening.

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Last update: October 17, 2007