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Strong jobs report sends 10-year reeling

Unemployment rate - LTEnlarge GraphThe Employment Situation Report is widely followed and is the biggest driver of monetary policy

The Bureau of Labor Statistics puts out the Employment Situation Report monthly. It contains a tally of the jobs created, the number of people in the workforce, the length of the work week, the number of people employed part time who would rather be employed full time, and then a breakdown of the statistics among demographic data.

The state of the labor market is the number one focus of monetary policy right now. The Fed has explicitly targeted an unemployment level (6.5%) that it needs to see before they will consider raising interest rates. They have not established a specific level for ending asset purchases, otherwise known as quantitative easing.

Highlights of the report

The economy created 195,000 jobs in the month of June. The May number was revised up from 175,000 to 195,000. April was revised upward as well. The unemployment rate was unchanged at 7.6%. Average hourly earnings increased .4% and the average workweek held steady at 34.5. The underemployment rate ticked back up to 14.3% from 13.8%.

The number of long-term unemployed people fell slightly to 4.3 million. The biggest negative of the report was that the labor force participation rate remained depressed, similar to 1970s levels. A low labor force participation rate makes the unemployment numbers look artificially low. A long-term unemployed person who has not been actively seeking employment does not count as part of the labor force, and, therefore, they are not counted among the unemployed. The other negative was that it looked like the job growth was mainly in the part-time / temporary sector.

The 10 year bond sold off heavily on the report as the yield jumped from 2.5% to 2.74%.

Impact on mortgage REITs

Non-agency mortgage REITs, such as Chimera (CIM), PennyMac (PMT) or Two Harbors (TWO), which invest in non-government guaranteed mortgage backed securities, are sensitive to the economy as defaults can influence returns. The unemployment rate is by far the biggest driver of defaults. Agency REITs, such as MFA Financial (MFA) or American General (AGNC), that invest in Ginnie Mae (government guaranteed) or conforming (Fannie Mae – government sponsored), consider defaults to be just a different type of prepayment. It is typically the higher coupon loans that have default issues, and once the loans become 90 days delinquent, they are typically purchased out of the pool by the lender and repaid at par. This has the effect of lowering returns for the portfolio going forward.

All REITs are highly sensitive to the level of interest rates. The general interpretation of the report was that the Fed’s plans regarding tapering quantitative easing remain in place. Some have speculated that the report would push up tapering from the December meeting to the September meeting. The 10 year bond got clocked on the report, as did the REITS.