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Federal Reserve Districts

First District--Boston

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Business activity continues to expand overall in the First District, but individual firms' gains show some choppiness. Most contacted manufacturers and advertising and consulting firms saw revenues rise in the most recent quarter on a year-over-year basis, while retail results were more mixed in May and June. Residential real estate markets continue to show positive effects of the homebuyer tax credits, but activity slowed after the April deadline. Respondents in commercial real estate were mostly downbeat based on office job forecasts, but building sales are picking up, in some cases at distress prices. A few firms with rising sales are increasing their headcounts, but most are holding employment steady. Input costs for some metals, oil- and food-related products have risen, but sales prices are mostly stable.

First District retailers report mixed sales results for May and June; year-over-year same-store sales figures range from down close to 3 percent to increases of about 3 percent. The majority of contacts express concern over consumer confidence, and even those retailers reporting sales increases voice a cautious outlook.

Inventory levels are mixed, with some increases due to softening sales; on the other hand, decreased ocean freight capacity is raising concerns regarding firms' ability to restock in a cost-effective and timely manner. Capital spending is also mixed, with some retailers spending on new store openings, remodels, and IT systems, while others remain cautious. Headcounts are growing modestly, with most increases attributed to opportunistic hiring and new store growth, but a few contacts indicate that staff cutbacks may occur in the future. Retailers note cost increases for cotton and food-related commodities.

Manufacturing and Related Services
Many manufacturing firms are still finalizing their second quarter results, but the vast majority of those contacted report optimism about demand. The specific sales reports range from "extraordinary demand" at a semiconductor firm to less-than-anticipated demand at two firms making life science equipment and medical devices. In particular, the semiconductor firm reports sales in the second quarter were 17 percent above their pre-recession peak. Other semiconductor-related firms also report relatively strong sales. In addition, second quarter results appear to be somewhat better than expected at a business services company as well as a company whose sales of outdoor-related products benefited from the warmer-than-average temperatures. By contrast, among firms reporting weaker-than-expected sales growth, one speculated that it was due to a slowdown in European demand and the other to state and local budgetary cutbacks on medical equipment. In general, nearly all of the manufacturers surveyed feel that demand will continue to improve gradually in the second half of the year as well as in 2011.

Most contacted manufacturing firms continue to report limited price pressure. Input costs remain relatively stable. One manufacturer who uses many raw metals in the production process says that prices remain higher than a year ago, but have come down somewhat since the first quarter. A couple of firms who use oil-related products also report somewhat higher input prices. Selling prices are generally fairly stable. One manufacturer that implemented a moderate (3 percent) price increase in the first quarter says that the increase held. By contrast, a firm that makes both capital equipment and consumables cites downward price pressure on the capital goods they sell (as companies remain wary about the costs of large items), but not on the consumables; this has been the case for about a year.

Employment continues to be steady at nearly all responding manufacturing firms, and most say they are unlikely to expand headcount substantially in the near term. A number of firms plan to hire to support new product lines or in divisions that are experiencing robust growth. A semiconductor-related firm, in particular, plans to increase its engineering workforce by about 150 by year-end; that firm's employment is already above its pre-recession peak due to strong demand.

Manufacturers once again report that their planned 2010 capital expenditures are in line with or somewhat higher than their expenditures in 2009. Planned increases are primarily for new product releases and/or infrastructure and IT-related improvements. Credit supply remains adequate for firm investment, and many manufacturers also report having adequate cash on hand for investment purposes.

Overall, contacted manufacturers are generally optimistic about the second half of 2010 and 2011. The firms remain cautious, however, as uncertainty continues to surround the domestic and foreign demand environments.

Selected Business Services
Consulting and advertising contacts in the First District generally report increased demand for their services in the second quarter of 2010, although a few say demand is flat. Among those seeing increases, revenue rose 8 percent to 25 percent year-over-year. Contacts cite healthcare and private equity industries as markets in which activity increased; a consulting firm also notes a significant increase in demand from the U.S. government regarding international development and healthcare issues. One contact reports that the payment cycle from its clients lengthened in the second quarter, slowing revenue growth.

Consulting and marketing firms indicate that business costs are stable and they are also generally holding their list prices steady, although some firms have been able to remove the price concessions they made in 2009. Several companies mention that they are replacing their laptops and purchasing new software licenses. Employment is mostly steady, with firms simply making replacement hires or modestly increasing the number of employees; more hires are expected in the second half of the year. Wages are either stable or rising slightly, by 2 percent to 5 percent.

Advertising and consulting contacts are optimistic about their firms' performance in the second half of the year, primarily based on the increasing volume of sales and the improving economic situation. However, many respondents see downside risks to this outlook, notably the chance of a double-dip recession; firms that contract with the government also note that budget cuts in response to deficit concerns would harm their businesses.

Commercial Real Estate
Commercial real estate contacts give mixed reports this round. Leasing activity is flat in Hartford, where market sentiment remains subdued. Between the first and second quarters, Hartford's office vacancy rate rose by close to 2 percentage points while rents were roughly flat. Industrial vacancy in Hartford also rose over the quarter, but by less than a percentage point, and industrial rents were flat. Hartford's investment sales market remains largely dormant. The word from Providence is more upbeat, as leasing activity remained solid in recent weeks and rents have reportedly stabilized. Business sentiment in Providence is described as more optimistic and less uncertain than it was earlier in the year. Absorption was roughly zero across Rhode Island. Office-building sales in Rhode Island remain scarce, but the industrial sales market saw some significant transactions. In Boston, one contact remains largely negative about current market conditions and near-term prospects, emphasizing slow job growth and the high office vacancy rate--currently around 20 percent in greater Boston. Leasing velocity is described as either steady or up slightly, but tenants retain very strong bargaining power on rents and improvements. Contacts say investors are bidding aggressively for fully leased, high-quality properties in greater Boston, especially apartment buildings; at the same time, some investors are purchasing distressed properties (with high vacancy rates) in the suburban corridor at steep discounts and betting on a solid recovery.

With regard to commercial real estate debt markets, one noteworthy development is that special servicers (who manage CMBS issues) are reportedly starting to dispose of an increasing number of securitized mortgages in default rather than continuing to extend troubled loans. This trend is expected to accelerate over the next 6 to 12 months. At the same time, banks continue to hold large sums of distressed commercial real estate debt and have not yet initiated large numbers of foreclosures. Contacts across the region remain concerned about the potential impact of inevitable foreclosures, especially if a large number occur in a compressed time period; contacts say, however, that New England is likely to fare relatively well compared to other regions with respect to commercial foreclosures.

In Hartford, expectations for market turnaround were pushed back a quarter, out to late 2010. In Boston, contacts expect net absorption to remain slow, and predict that office rents still have further to fall, but were uncertain as to whether job growth (and related demand for commercial space) would continue at current levels or become weaker in the second half of 2010. The outlook for Providence is cautiously optimistic, but "optimistic" was defined as slow growth rather than further deterioration.

Residential Real Estate
Residential real estate markets in New England continue to experience large year-over-year sales increases in May and into June. Median home prices also increased modestly year-over-year in May, although median condo prices were somewhat mixed. While April 30 was the deadline to sign a "binding sales contract" in order to be eligible for the homebuyer tax credits, buyers are allowed to close these deals as late as September 30 (extended from June 30). The strong sales numbers of May and June thus reflect closings on pre-April 30 contracts spurred by the tax credits. Respondents report that activity has slowed considerably since the expiration of the tax credit. Sales numbers will soften over the next couple of months as a result of this slowdown, although respondents are uncertain whether sales will show year-over-year declines. Pending sales of homes and condos in Massachusetts dropped 16 percent and 21 percent year-over-year in June, respectively.

A New Hampshire contact says that some types of homes are still selling well, notably those in convenient locations near major highways. Meanwhile, prices in rural New Hampshire are "plummeting." In addition, high-end vacation homes are starting to move again after very low activity during 2008 and 2009. A Boston-area contact believes that pent-up demand among potential buyers (because inventory was low) will help moderate the size of the slowdown associated with the expiration of the tax credit.

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Last update: July 28, 2010