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Federal Reserve Districts

First District--Boston

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Business contacts in the First District report little further deterioration in the pace of activity in the second quarter or recent months compared with the last report, although actual results are quite mixed. Retailers--partly because many respondents this time are discounters--say their sales are increasing, and so do software and information technology firms, but real estate markets in the region remain very slow and most responding manufacturers indicate unit sales or orders are down compared with last year. Manufacturers report ongoing hikes in their selling prices. According to most respondents, the near-term outlook is for "more of the same" or further slowing, with some signs of improvement expected in 2009.

Retail and Tourism
Retailers in the First District cite mixed sales results for the months of June and July, with the majority of respondents reporting year-over-year sales increases. Several contacts say consumers are cautious in their spending and are more focused on seeking value because of the economic downturn.

Inventory levels and headcounts continue to be tightly managed across the First District. Capital spending reports are mixed, with some retail contacts modestly pulling back spending and others continuing their capital spending as planned. Most respondents are still coping with the effects of high oil prices, but one notes that these cost pressures have abated somewhat.

Tourism in the Boston area has been "surprisingly good." While room rates are softening, tourism is up year-over-year; museums and area attractions report significant growth in visitors. Business and international travel both remain strong.

Overall, most contacted First District retailers are cautiously optimistic in their outlook, even though they expect the next few months to be a continued challenge.

Manufacturing and Related Services
Two-thirds of First District manufacturers and related services providers contacted in August indicate that sales or orders were flat to down year-over-year in the second quarter or more recent months; for a couple of these firms, revenues were up but volumes were down. Two-thirds of the firms also anticipate further declines in the second half of 2008 and early 2009. They report that economic malaise is spreading as industrial customers turn cautious, postpone expansions, and undertake preemptive restructuring. Contacts serving the residential and, increasingly, the commercial construction industries, auto makers, commercial airlines, non-aviation transportation, semiconductor makers, and the healthcare industry report declines in orders or sales. By contrast, firms with customers in the alternative energy or information technology (IT) industries or producing labor-saving or sophisticated equipment say that sales continue to grow. While contacts generally report that foreign sales have been an important source of strength, many firms express concern that foreign demand growth is now slowing, especially in Western Europe and Japan, but also in emerging Asia.

Three-quarters of contacted manufacturers reportedly face rising input costs and point to fuel and energy, petrochemical, and rolled steel prices in particular. A few firms note with relief that oil prices have subsided and that natural gas prices are little changed from year-ago levels. In response to input cost pressures, two-thirds of the contacted firms say that they have raised their selling prices from 2007 levels by from 3 percent to 8 percent; a minority have posted two prices increases in 2008 and are planning a third. Most firms find that "everyone" understands the need for these price hikes; thus, contacts are usually able to pass at least half of their increased material costs on to their customers. By exception, contacts in the IT industry report that selling prices are generally stable.

Two-thirds of manufacturing contacts have reduced their workforce--generally modestly--from year-ago levels. No firm expects to increase its head count; a minority plan further cuts or a hiring freeze, while a few await third and fourth quarter numbers to determine the need for further layoffs. Still, scientists, engineers, and other skilled labor reportedly remain hard to find. Wage increases for 2008 or planned for 2009 are generally 3 percent to 4 percent, but two firms have delayed or asked some workers to forego raises. Others are tightening their grip on merit increases or finding ways to cut benefits costs. While a few contacts note increased complaints from workers facing high gas and food prices, none has responded to these wage pressures; most of this group believes their staff understands that the firm cannot "make them whole."

Manufacturers generally expect their capital spending to remain on budget at or above 2007 levels, but a few are taking a harder look at discretionary spending. None of these firms suggests that financial market distress is affecting its investment spending. Only one is seeking more credit than it has been able to negotiate to date.

Looking to 2009, half the manufacturers are "cautiously optimistic" or believe that the next 18 months could turn out "OK." The other half are "anxious and concerned" and view the economic environment as "challenging" and "volatile." They expect it will take several quarters to resolve problems emanating from the housing, energy, and financial markets.

Software and Information Technology Services
New England software and IT services firms report flat to favorable results in the second quarter of 2008, with nearly all firms showing year-over-year growth in revenues. At the extremes, one contact describes business activity as a "gentle ebb and flow," while another reports a robust pipeline and a 29 percent year-over-year increase in revenues. No contacted firm is cutting its headcount, and some continue to expand slightly. One contact notes that the market for skilled labor remains tight and says his firm has raised average wages by 10 percent over the past year, with the largest increases for skilled engineers. Other contacts report pay increases in line with longer-term trends, around 3 percent to 4 percent. Software and IT firms in the First District are sustaining high profit margins, with a few contacts saying their sector is generally the last to be hit by a weakening economy. Through the end of the year, most responding firms are projecting continued growth, but at a somewhat slower pace than recently.

Staffing Services
Staffing respondents in the First District report varied outcomes during the second quarter of 2008, with comparable year-over-year revenue changes ranging from minus 10 percent to plus 19 percent. Demand is strong for workers in the biopharmaceutical, manufacturing, software, and web development industries, while demand from the financial and engineering sectors is down. Overall labor supply has improved, with one contact attributing the influx of candidates to the poor economic climate; nonetheless, filling upper-level positions remains a challenge for most staffing firms. Indeed, one contact says the skilled labor market is "still candidate-driven," with applicants choosing between multiple offers. For the remainder of the third quarter and going into the fourth, New England staffing firms are generally "cautiously optimistic."

Commercial Real Estate
Commercial real estate contacts in New England report few major changes in market conditions since the last report, when sentiment leaned toward the negative. A Hartford contact describes rental rates and vacancies in the office sector as holding steady, despite very low leasing volume. He has not seen significant layoffs and space give-backs among downtown tenants, but he expects the employment picture to worsen in the coming months. A commercial broker in Boston describes the downtown office market as "still slow but not dead," with very little new job creation to bolster demand, but no major tenant exodus as of yet; he estimates that rent growth in Boston is close to zero and vacancy may have edged up a point. The Rhode Island market is also described as slow but not dismal. In downtown Providence, office leasing demand has been adequate, but tenants are driving harder bargains. Several contacts say retail markets may be softer than office markets.

Building sales continue to be down sharply relative to last year, due to ongoing credit tightness and significant gaps between asking prices and bids. Capitalization rates are expected to continue to rise in response to increases in long-term interest rates, so downward price pressure will continue and default risks will continue to rise. Against these trends, a small banking contact in Boston states that his bank continues to enjoy a higher-than-usual deal volume, typically involving the refinancing of well-stabilized properties. To meet the above-normal demand for its loans, the bank has sought out new deposits by offering higher rates on CDs, with considerable success.

The outlook remains downbeat and some contacts say it has worsened. One commercial broker, for example, pushed back his forecast of when the market will begin to improve to the second half of 2009. Contacts expect overall leasing and sales activity to remain slow for a while, and express uncertainty as to whether fundamentals will deteriorate further, or simply stagnate, before recovering.

Residential Real Estate
Residential real estate markets in New England continue to show significant year-over-year declines in sales volume and median prices. Home sales in Maine declined 24 percent year-over-year in June, while Rhode Island and Massachusetts home sales decreased 15 percent, and Massachusetts condo sales declined 20 percent. New Hampshire home sales declined 6 percent year-over-year in July, and home sales year-to-date were down 25 percent through July in Connecticut compared to a year earlier.

Median home prices in Massachusetts, New Hampshire, and Connecticut declined 8 percent year-over-year in the most recent period, while median condo prices in Massachusetts stayed flat. Median home prices decreased year-over-year in June by 6 percent in Maine and by 14 percent in Rhode Island. Home price declines are said to partly reflect increases in foreclosure-related "distress" sales.

The number of months of supply is generally higher in New England markets than it was last summer, but it has decreased from its peak earlier this year. One exception is Massachusetts, where contacts report a decrease in listings of houses and condos in response to falling prices that has made the market more balanced, even though sales have declined since last year. Several contacts are optimistic that the housing bill recently passed in Congress will have positive effects on New England markets.

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Last update: September 3, 2008