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

April 17, 2013

The following is the text of the Federal Reserve Board’s First District-- Boston.

Economic activity in the First District continues to expand modestly according to business contacts, although conditions are somewhat mixed across individual firms. Retailers generally cite slower than expected sales, and tourism has softened, partly on account of unseasonal weather. Over half of responding First District manufacturers report demand improvements in the first quarter; the rest are less upbeat. Most consulting and advertising firms say business is strong. Reports from the commercial real estate sector are more positive in this round than previously, with leasing activity improving in some markets. In the residential sector, limited inventory is said to be constraining home sales in the region, but median home prices are rising modestly. Contacts say hiring reflects demand growth, so few firms are adding substantially to headcounts except in the consulting sector. Price pressures are minimal. Most respondents expect current trends to continue, yielding modest to moderate growth in the second quarter and the second half of the year.

Retail and Tourism Retailers contacted for this round cite mixed results for first quarter 2013. One reports that year over-year comp store sales were up 2.5 percent to 2.6 percent, while others report slower than expected sales. Some contacts attribute their slowdowns partly to the prolonged winter weather, noting that while this winter has been unseasonably cold in some regions, winter 2012 was unusually mild. Demand remains strong for clothing, shoes, and home furnishings. Inventories are in good shape, and any price increases are moderate. Contacts continue to expect that 2013 sales increases will be in the modest single digits.

The tourism business softened in February and March compared with a year earlier; some of this slowdown is also attributed to weather-related factors, especially for restaurants and museums. January through March is seasonally the slowest period for leisure travel. Tourist activity from Europe dropped about 5 percent this quarter compared to a year ago. Corporate business travel and entertaining remain strong.

Manufacturing and Related Services Conversations with a dozen manufacturing contacts paint a mixed picture. More than half report that demand for their products improved in the first quarter versus the previous quarter or a year earlier. The two firms reporting the strongest sales growth were in the health care sector--a drug company and a medical device manufacturer-- and both reported spectacular growth. At the other end of the spectrum, two firms in the semiconductor business report that sales continue to languish. One, a maker of analog devices, acknowledged that the semiconductor business is cyclical, but said that the duration of the current slowdown is unlike anything he had encountered in his years in the industry. Hiring patterns largely mirror sales growth, with four firms reporting substantial hiring, three citing stability, and five firms reporting staff reductions. The two health care-related firms led the pack, I-2

increasing staff at annualized rates of 15 percent to 18 percent. For the medical device manufacturer, the hiring was largely support personnel such as sales, marketing, and back office. Weakness in demand is not yet translating into lower capital expenditures, with only one firm reporting a reduction. Half the firms noted increases in spending and the rest reported no change. One of firms engaged in substantial capital spending relative to sales is the analog semiconductor firm reporting continued weakness in sales; the firm’s managers indicate they remain confident that the long-term growth patterns in the industry will justify their investment.

Looking forward, only one-third of manufacturing respondents were negative about the outlook. Most of the rest were optimistic or “cautiously optimistic.”

Selected Business Services Consulting and advertising contacts in the First District report a generally strong first quarter and were positive about their firms’ recent performance and near-term outlook. Marketing and advertising contacts note an uptick in growth due to clients in stronger financial positions and with more money to spend. Several contacts report robust demand for health care consulting services as the industry adapts to massive changes attributable in part to the Affordable Care Act. Economic consulting remains strong because of high levels of complex high-stakes litigation; management and strategy consulting contacts cite improved business conditions as clients have become more optimistic and seem to believe that it is time to invest for future growth. The only contact to report a bad quarter works mostly with the federal government and has been heavily affected by fiscal contraction.

Contacts generally report cost increases around 2 percent and most firms either raised their rates between zero and 5 percent, or plan to do so later in the year. Several firms have done no hiring because of strong recent hiring or a desire to wait until stronger demand seems more certain. Other firms report stronger hiring, particularly related to health care consulting, in order to deal with increasing demand. Most contacts expect growth to remain strong or to pick up through the rest of 2013. One exception is a government contractor who is too uncertain about future fiscal policy to offer a forecast. Other respondents seem minimally concerned about fiscal issues, the European debt crisis, and the state of the macro economy, a change from the recent past. One contact specifically notes that client businesses seem to have become comfortable with the level of uncertainty in the economy and are deciding to move forward with investment and business expansion rather than wait for more clarity; several other contacts’ reports are consistent with this characterization.

Commercial Real Estate Reports from commercial real estate contacts in the First District contain much good news. Boston contacts uniformly remark that the office leasing market has firmed up in recent months and that the vacancy rate is down significantly from one year ago. Activity is particularly strong in the seaport district, but financial district towers are also seeing absorption of long-vacant space. Investment sales

activity in greater Boston remains brisk, especially for multifamily structures. Planned construction projects in Boston picked up considerably, with a focus on mixed-use projects, and should lead to job gains for the sector moving forward. In Hartford, the state government purchased a large downtown office tower, absorbing a large block of Class A space, boosting business sentiment and, it is speculated, helping put upward pressure on rents. In Portland, the retail property market saw healthy leasing activity and investment sales activity picked up modestly. In Providence, progress continues on some large office leasing deals (despite not yet leading to completions), investment sales activity continues to rise, and business sentiment is seen as increasingly optimistic. On the downside, Hartford saw stagnant office leasing and virtually no construction activity, while Portland’s office vacancy rate remains stubbornly high at 12 percent. Small-scale commercial real estate loan demand remains well below last year’s pace, according to one regional lender. Construction materials costs are on the rise, putting pressure on profit margins at small firms in particular.

In Portland, property fundamentals are expected to remain flat despite forecasts of healthy transaction volume and a possible increase in hiring by some large firms. In Hartford, the outlook remains cautiously optimistic. In Providence, upside risks to absorption and rents remain, while the federal sequester poses a threat to the state’s defense industry. In Boston, one contact expects improvement in fundamentals to remain slow while another expects absorption to accelerate if employment growth continues at its current pace. Boston is expected to remain a magnet for investors owing to its strength in the health and education sectors. However, Boston contacts continue to express concern over property valuations that appear high in relation to income- growth potential.

Residential Real Estate Strong consecutive months of year-over- year growth in single-family homes sales halted in February, with some New England states experiencing marginal increases and most observing a decline. According to contacts, buyer demand remains strong, but dwindling inventory levels have hampered growth in sales. Meanwhile, median sale prices across the region rose from a year ago. Contacts attribute the price rise to the declining stock of distressed properties compared to a year ago as well as to the general decline in inventory reducing supply relative to demand. Particularly in urban areas throughout New England, decreasing inventory levels have placed upward pressure on prices. In the Greater Boston area, contacts report that multiple bids on properties have become more common as inventory continues to dwindle.

Contacts express concern that low inventory levels in the next several months could discourage buyers and continue to be a significant factor limiting the growth of sales. On the other hand, inventory levels may rise with the beginning of the busy spring season. In addition, rising prices will eventually lure into the market sellers who have been waiting for the value of their homes to pick up before listing them.

SOURCE: Federal Reserve Board

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