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

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

The First District economy continues to expand modestly, according to business contacts. All but one retailer and most manufacturing and selected business services contacts cite sales or revenue increases in recent months. While existing home sales were below year-earlier levels in three of the six New England states, home prices continued to rise; at the same time, commercial real estate in the region maintains modest strength. Economic and health care consulting is the only sector citing significant net hiring. Most contacts indicate that price pressures are a non-issue. The outlook is generally positive.

Retail and Tourism

Retail respondents in this round report December year-over-year sales changes ranging from a low single-digit decrease to an increase of 10 percent. Two contacts ended their fiscal years on December 31 and cite preliminary tallies showing 2013 sales up 1.5 percent and 5.0 percent compared to 2012. The latter result exceeded earlier expectations of 2013 comp store sales increases of 1.7 percent to 3.0 percent over 2012; this contact attributes the better-than-expected performance to increasing consumer confidence observed since late August. Respondents say demand is strong across all apparel categories, home furnishings, and items related to home improvement. One contact reports that inventories were down significantly due to stronger-than-expected sales, while others report “good” inventory levels. Retail contacts continue to cite steady prices and predict modest price increases for 2014 in the range of 1.25 percent to 2.0 percent. As noted in the previous round, respondents say consumer sentiment is improving based on a better outlook for the U.S. economy. One contact expects consumer spending in 2014 to be constrained by rising financing costs for mortgages and automobiles, given that wage increases remain modest at best.

Manufacturing and Related Services

Of the 11 firms contacted in this round, none reports falling sales and eight report increasing sales. Among the three firms reporting no change were a chemical firm for whom the flat demand was an improvement after falling sales and a publisher who cited falling demand for information from the financial services sector. Another firm, a manufacturer of storage devices for computers, said that they had lowered their earnings guidance for the fourth quarter. Many other contacts report relatively strong sales. A medical equipment manufacturer says that growth was strong not just for its new products, which typically grow at double-digit rates, but also for legacy products where there was pent-up replacement demand. A manufacturer of semiconductor equipment cites very strong demand, suggesting that the semiconductor industry is on an up-cycle after weakness in recent quarters.

Many contacts say they are attempting to reduce inventories. A manufacturer of medical equipment indicates that an exceptionally large backlog has allowed them to tailor production more precisely as well as to lower inventories. In general, respondents report little pricing pressure from either suppliers or customers. One exception is a frozen fish producer for whom prices of shrimp and haddock were “through the roof.” Another exception is a producer of parts for the commercial aircraft industry who said that Boeing has been putting exceptional pressure on its suppliers to lower prices, something reported earlier by other firms in that industry. A publisher plans employment reductions, but most manufacturing contacts report modest hiring plans, in line with or below sales growth.

All but three contacted manufacturers cite increased capital expenditures. A firm that makes parts for commercial aircraft said it had revised up its capital expenditures by 20 percent in the fourth quarter after a similar-sized increase earlier in the year. A drug firm says uncertainty about the manufacturing R&D tax credit had negatively affected investment plans. Another drug company says capital expenditures are falling because of financial problems at their parent company in Japan. The outlook is positive for all respondents except the publisher who is concerned that demand from the financial services industry will remain problematic in 2014.

Selected Business Services

Consulting and advertising contacts report a strong fourth quarter, consistent with a sustainably, but not rapidly, growing economy. The strongest business is driven by the healthcare industry, where demand has come from providers who need help preparing for and complying with the Affordable Care Act (ACA) and from providers and insurers who desire to use IT and analytics to improve efficiency. Economic consulting remains a strong growth industry and strategy consultants report mixed results, with the industry split between larger firms who have done very well and smaller firms whose revenues are flatter. Marketing contacts estimate industry-wide growth of 6 percent to 7 percent, driven by large corporate orders and a continued shift in demand towards higher-value items as companies have more to spend on marketing and branding. Overall, consulting and marketing contacts report that large corporate clients have cash and are increasingly willing to spend it. Finally, a government consultant reports a slight drop in revenues and a reduced backlog as the sequester and federal budget uncertainty continue to reduce agencies’ ability to purchase his firm’s services.

Contacts cite minimal cost increases, with the exception of a healthcare consulting contact whose regulatory compliance costs have skyrocketed due to fragmented state regulatory frameworks. Wages generally rose from zero to 3 percent, although several firms paid high bonuses because employees were busy. Firms raised the rates charged clients between zero and 4 percent, with firms facing stronger demand at the higher end of that range. Healthcare and economic consulting contacts report either rapid hiring (restrained by the difficulty of recruiting some skills) or a lull after recent rapid hiring. Strategy consultants, marketing contacts, and the government contractor cite flat employment. Firms say they are generally able to find qualified workers, with the exception of software engineers and IT personnel.

Contacts are positive about 2014 and expect their recent growth to either continue or increase. Contacts express minimal concern about macroeconomic factors, with the exception of a healthcare consultant who worries that persistent high unemployment will reduce healthcare utilization. Several contacts mention some concern that Congressional decisions may yet cause a crisis. Overall, respondents are bullish about the future and worry primarily about idiosyncratic firm-specific factors.

Commercial Real Estate

Commercial real estate leasing activity in the First District held roughly steady on average in December, while investment sales activity and construction remained robust or strengthened significantly, according to contacts from across the region. In the Boston area, the Seaport District maintained a steady, “impressive” leasing pace, and office leasing activity picked up in some suburban areas. In Boston’s Financial District, however, the vacancy rate remains in the mid-teens, allowing modest rent increases that are, according to one contact, probably only large enough to cover rising costs. Investment sales activity saw a year-end burst of activity in Boston, with strong contributions from foreign investors, pushing capitalization rates and loan spreads to historically low levels and reigniting concerns that prices are too high relative to reasonable expectations of rent growth. In Rhode Island, commercial leasing inquiries picked up modestly in December, but new tenants are still scarce. Investment sales activity in the state remains brisk and new developments--driven by the education sector--are slated for downtown Providence. In Connecticut, investment sales activity remained strong in December and, while leasing activity held roughly steady, contacts say some large, vacant tracts of office space in greater Hartford may be effectively obsolete and unlettable.

Concerning construction activity, the pipeline of planned multifamily properties in greater Boston continued to dwindle, consistent with the perception among some contacts that the large number of units currently awaiting delivery may produce a glut. At the same time, planned construction in the education, health care, and life sciences sectors increased significantly in recent months, and the number of retail projects under construction in greater Boston appears to be rising, according to contacts. A regional lender closed a higher volume of commercial real estate loans in 2013 than in 2012, despite facing brisk competition and steady, intense pressure on interest rate spreads. The outlook among contacts for 2014 is generally optimistic. As reasons for optimism, one contact perceives that recent developments in Washington have reduced economic uncertainty, while some others say that macroeconomic “momentum” is on the rise. Downside risks include the upcoming costs to businesses of compliance with the ACA and the trend toward office downsizing on a space-per-person basis.

Residential Real Estate

Residential real estate markets in three New England states followed national trends, as October or November sales of single family homes and condominiums came in below year-earlier levels in Massachusetts, New Hampshire, and Connecticut; meanwhile home sales increased year-over-year in Maine, Rhode Island, and Vermont. As happened nationwide, the median sales price for single family homes rose in four of the six states. After many consecutive months of year-over-year sales increases, regional contacts attribute the recent sales declines to lower consumer confidence as a result of the most recent government shutdown, to a shift in sales toward earlier quarters due to lower interest rates at the time, and to a lack of inventory. One source notes, “[the market] lost a little steam in Q3 and continued at a slower pace in Q4.” A Massachusetts contact says limited inventory is constraining the market, as the available months of supply for single family homes and condominiums were 4.3 and 2.8 months respectively in November. “New listings are up, but we have been burning through inventory,” reports a source in Massachusetts. Despite the recent decline in unit sales, New England realtors agree that 2013 has been a good year overall and they remain optimistic about sales increases looking forward.

SOURCE: Federal Reserve Board

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