Interest Rates Will Rise. The Good News is Why

CALABASAS, CA—In a bad-news-that's-actually-good-news report, Marcus & Millichap says the Federal Reserve is on track to raise its benchmark short-term interest rate by year's end. The good news in that is the reason why the Fed is likely to maintain its present course: “Hiring in May spotlighted a US economy that is finding its footing and gathering momentum following the weather-induced lackluster results of the first quarter,” according to MMI's latest Research Brief.

Given the jump in job creation to 280,000 last month and upward revisions to prior months, it's clear that “growth in US payrolls is back on track to align with last year's robust pace,” MMI says. Higher employment levels, evidence of a more substantial pace of wage growth and broadening economic strength are converging” to keep the Fed on its general schedule for raising interest rates.

This past December, Hessam Nadji, senior EVP at MMI, took the long view of rate increases during an interview on CNBC. “Better job growth” and mild inflation coming back into the system as a result of the gradual fall in unemployment provide “an offsetting factor against higher interest rates,” the GlobeSt.com Thought Leader told interviewers during a segment of CNBC's Worldwide Exchange. The reason, he said, is that “it's the better economic conditions that are generating the reason for interest rates to be higher.”

However, MMI's latest Research Brief makes it clear that economic conditions still haven't reached par across the board. Although residential and commercial projects have begun picking up, construction payrolls are still 1.1 million lower than their pre-downturn peak, for example. “Government and manufacturing jobs also face substantial deficits from prior levels, whereas education and health services expanded throughout the economic downturn, adding nearly 3.1 million positions. The shale oil boom lifted natural resources and mining staffing, but so far this year the sector has lost 68,000 jobs due to lower oil prices.”

Further, the disparity in job gains also cuts across demographic lines. “The unemployment rate for 20- to 24-year-olds, for example, jumped to 10.1% last month, underlining the persistent difficulties young workers face in starting careers, according to MMI. At the other end of the age spectrum, older workers now remain in the workforce longer to build retirement savings. Accordingly, the workforce ages 65 and older is growing, and its unemployment rate stands at 3.2%.

For the commercial real estate sector, there's an upside to the disparity in employment. “The continuing inability of the youngest parts of the population to find work and form households represents a source of untapped demand for rental housing,” according to MMI's Research Brief. “Despite the modest contribution from 20- to 24-year-olds, the US apartment sector is nonetheless flourishing.” That being said, MMI notes that with 250,000 new apartment units coming on line this year, the sector's vacancy rate will tick upward 10 basis points to 4.8%.

Conversely, office is poised to see vacancies decline by year's end. Professional and business service employment is running far ahead of the pre-recession peak, and MMI predicts that growing demand coupled with relatively little new supply will drop the vacancy rate for office to 14.5% by year's end, an 80-bp drop.