April 14, 2010 Federal Reserve Districts First District--Boston

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Business conditions continue to improve in the First District. Contacted retailers cite sales increases, manufacturers say demand continues to grow, and advertising and consulting firms report modest revenue increases. Home prices appear to be improving along with sales in most of the region's residential markets, while commercial real estate appears to be stabilizing although potential defaults remain a concern. Most New England employers are no longer shedding workers, and many are restoring recession-induced cuts in wages and benefits. Both input and selling prices are mostly said to be stable. Retail Contacted retailers in the First District report positive sales results for the early months of 2010; year-over-year same-store sales vary from flat to increases of about 20 percent, with " improved sales tone" across the board. Contacts attribute the uptick in sales to strengthening consumer confidence, strong marketing, and having "the right product and the right price." All respondents are cautiously optimistic in their outlook. Inventory levels are primarily on target, although one contact notes a decrease because of unexpectedly strong sales. Capital spending is more robust than in previous reports, with contacts spending on new store openings, store remodels, IT systems and other technology. Several respondents report slight increases in headcount and the reinstatement of prior wage cuts. Vendor and selling prices are said to be stable, although one contact notes an increase in food-related commodity prices. Manufacturing and Related Services Most manufacturing and related services contacts headquartered in the First District continue to report improving demand for their products in the first quarter of 2010. A furniture maker cites sales increases of more than 20 percent in the first quarter of 2010 relative to a year ago, a metals fabrication business reports similarly robust revenue growth, and business is also strong at a local semi-conductor firm. Overall, the manufacturers serving IT, electronics, and business services industries report the greatest increases in demand. By contrast, firms selling machinery and equipment to industrial customers and those supplying real estate-related sectors, especially commercial real estate development, say that business has stabilized or is improving somewhat, but they expect underlying demand to remain relatively sluggish for the rest of the year. In addition, some firms caution that growth in the first half of 2010 appears strong simply because demand in the first half of 2009 was so weak. There has also been a bounce in growth at some firms from one-time inventory corrections. Input costs for manufacturers are generally unchanged, with the exception of most metals, for which prices are rising. Many companies report that they are holding selling prices steady, although a few have managed (or plan) to implement modest increases this year; they face limited pressure to reduce their selling prices. The employment situation in the manufacturing sector remains relatively unchanged. Two notable exceptions are a metals fabrication firm that has increased its workforce about 15 percent relative to a year ago and a large diversified equipment and technology manufacturer that expects to continue layoffs through this year. At most of the remaining firms, hiring in the U.S. is expected to remain relatively flat or increase only slightly for 2010. Manufacturers continue to try to restore wage cuts and/or unfreeze wages. Most firms report instituting or planning to institute modest wage increases of 2 percent to 3 percent this year. Virtually all contacts continue to express concerns regarding rising health care costs. Most manufacturing respondents report that their planned capital expenditures for 2010 are level with or slightly greater than their expenditures in 2009. Most of the firms' domestic capital expenditures will go toward expanding IT investment and/or their research and development functions. Respondents commenting on financing conditions say they have improved. Virtually all the contacted manufacturing firms remain cautiously optimistic that business conditions will continue to improve as the year progresses. The consensus, however, is that it may take a while for underlying demand to pick up substantially, and 2010 may turn out to be a transition year. Selected Business Services Most First District advertising and consulting contacts report modest quarter-over-quarter increases in revenue in the first quarter of 2010, although some report flat to slightly negative growth. Nonetheless, all agree that demand is up substantially from the first quarter of 2009, with one firm's growth exceeding 30 percent. As some uncertainties about healthcare reform were lifted, for example, consulting demand from the healthcare sector showed a rapid increase, and this strong growth is expected to continue throughout the year. Consulting demand from private equity firms increased slightly as well. Most respondents made large price cuts in 2009, in the range of 10 percent to 20 percent, with only a few holding their prices steady. Now prices are being raised, but they remain below their pre-recession levels. Regarding compensation; some contacts have kept and plan to keep base salaries steady, while others have raised salaries from 2 percent to 10 percent. Performance bonuses are generally down. Most respondents intend to maintain current staff sizes, with only replacement hiring, but a few firms expect to increase headcounts by 2 percent to 15 percent by the end of the year, and one firm plans to further downsize by 5 percent. Advertising and consulting contacts generally say they are cautiously optimistic about the rest of the year, as some uncertainties remain. Most respondents forecast a slow recovery for their industry and project annual revenue growth for their firms between 5 percent and 10 percent, although some expect flat growth. They express concern about the availability of credit and the possibility of a double dip. Commercial Real Estate Commercial real estate fundamentals in New England have been roughly stable since the last report. In Rhode Island, the uptick in leasing activity seen in January has not been sustained and sales volume remained weak in recent weeks. Nonetheless, our contact notes that vacancy and rental rates in downtown Providence have stabilized. In Boston, leasing activity consists largely of renewals, and renewing tenants continue to give back significant blocks of space. Boston contacts have not seen sizable rent declines in recent weeks, but downward pressure on rents remains significant and tenants are reportedly bargaining hard for improvements and other concessions. However, owners with weak equity positions cannot secure financing for improvements and therefore cannot effectively compete for tenants. Vacancy rates in greater Boston are roughly flat or up slightly since the last report; apartment vacancy rates in Boston have increased less in the current downturn than have vacancy rates for office and industrial properties. In Hartford, the industrial market is currently the weakest sector, with 1.2 million square feet of vacant space added in the first quarter of 2010; fundamentals for office and retail properties were little changed over the same period. While Hartford's commercial real estate market was described as "stagnant" overall, consumer sentiment in Connecticut was perceived as improving. In the investment sales market, contacts report growing demand for commercial properties by institutional investors and life insurance companies searching for higher yields. In line with this trend, a commercial real estate lender in Boston has seen significant sales activity for fully-leased, low-risk properties, and his bank has lost bids to other, more aggressive lenders. A local asset management firm recently purchased a prime, mixed-use property in Boston among competition from multiple bidders. At the same time, investor sentiment is reportedly mixed as to whether prices have hit bottom, and significant gaps remain between bidding and asking prices in the riskier segments of the market. Looking forward, a few contacts express renewed concern about looming commercial mortgage defaults, as operating incomes and debt-service reserves continue to fall and equity in many properties remains weak. Defaults are expected to rise over the next 12 months and possibly beyond. While most contacts expect leasing volume to rise in the later part of 2010, none expect rents to increase significantly in the near term and one sees little upside risk to rents for at least five years, in Boston at least. Residential Real Estate Residential real estate markets in New England continued to show mostly positive signs in February. Home sales increased year-over-year in most parts of the region, with 14 percent increases in Maine and Massachusetts. Rhode Island home sales, by contrast, declined slightly year-over-year. Condo sales also increased significantly in Massachusetts and New Hampshire compared to February 2009. Prices also showed signs of stabilization as the median price of homes in February increased modestly year-over-year in Massachusetts, New Hampshire, and Rhode Island, and held steady in Maine. The median condo price in Massachusetts increased 13 percent year-over-year in February. While Massachusetts contacts are still concerned about low inventory, the 3 percent year-over-year decline in home listings was actually the smallest decrease in 23 months. These contacts hope that sellers will come back to the market as prices rise. Furthermore, the average number of days on market fell sharply across the region. Real estate brokers have been kept busy by the strong demand from buyers encouraged by the tax credit and low prices. Unfortunately, recent flooding in several areas has been a problem for some deals. 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