Global Unrest Unlikely to Prompt QE3
Powerful countervailing forces are at work in our economy. To the negative: the recent sharp increase in oil prices, the possibility of spreading unrest in the Middle East, the depressed housing market and the glut of distressed mortgages yet to be resolved, widespread local and state government fiscal shortages and a nation increasingly mindful of the growing national debt and with diminished desire for any more government intervention. To the positive: improving GDP and employment growth, continued stimulation of the economy over the next six to nine months via the second quantitative easing (QE2) by the Fed implemented last year, extended tax cuts, improved liquidity in the capital markets, pent-up corporate demand, as-of-yet tame core inflation and increasing global demand for U.S.-made goods and services.
It appears that these forces will combine to enable moderate growth in 2011 (GDP growth of approximately 3% and job growth of approximately two million, or 2%), with accelerated growth in 2012 as confidence returns to the marketplace. This means the Fed is unlikely to take further action upon expiration of QE2 in June. This is raising some concerns among investors, particularly those worried about rising interest rates over the long term.
Is QE2 working and should we be concerned about its expiration? Basically, yes it’s working and at this time, and a third round of quantitative easing or QE3 does not appear necessary. QE2 limited the rise in interest rates despite the short-term spikes early this year with the 10-Year Treasury yield now around 3.4%, a historically accommodative level. Most important, the measure brought capital out of safety and into the markets prior to the global turmoil, which has reversed this trend and caused a pull back in interest rates. The GDP grew at an annual rate of 2.8% in Q4 2010, and in February the nation added 192,000 jobs, the strongest performance since the recovery began. QE1 was targeted at bank recapitalization, and banks put a nominal amount of capital to work by lending it out. QE2 was structured differently, and is having a more direct impact on the capital markets.
Unless there is another major shock to the system, such as oil eclipsing $150 per barrel, QE3 appears unlikely because of reduced political will for further government intervention and concern about potential inflation. However, a significant tightening by the Fed for the remainder of 2011 does not appear to be in the works, either. While inflation is a major worry among emerging markets, which has prompted those countries to raise interest rates, the Fed will likely refrain for now, because the U.S. GDP and employment growth is still lackluster relative to long-term averages, unemployment remains high and there is virtually no wage pressure. Therefore, the timing of any significant Fed tightening just got pushed back to 2012.
This is at least partially good news for real estate investors as it points to low interest rates for some time. But it also means investors should be prepared for slower growth. Higher energy prices, if sustained, will cut into consumer and corporate demand. If the energy crisis persists or worsens, sentiment, which is already fragile, could turn overly cautious and threaten the economic recovery. Apartments are in the best position to withstand the worst-case scenario for the economy since consumers will favor renting over buying. The retail recovery is very fragile and depends heavily on consumer confidence, which could take a turn for the worst. Office and industrial properties are benefiting from renewed tenant demand for expansion, and could see new lease commitments put on hold if the situation worsens.
Investors have been here before and those who have taken the long-term view toward commercial real estate have experienced strong returns. Locking in low interest rates, acquiring assets with a specific and realistic plan for value enhancement and positioning assets for highest potential revenue growth based on the strength of the metro and submarket has paid off in past cycles, virtually all of which had macro economic or global issues of their own.
Hessam Nadji is managing director, research and advisory services, for Marcus & Millichap Real Estate Investment Services. Contact him at firstname.lastname@example.org or (925) 953-1700.
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