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September jobs report disappoints, December taper off the table

Given the Fed’s focus on unemployment, the monthly jobs report is by far the most important monthly economic report

The Fed has stated over and over that it will be guided by changes in the labor market when making monetary policy decisions. It also focuses on inflation, but the low level of inflation is giving the Fed the leeway it needs to target employment. The Fed has given guideposts about raising interest rates (unemployment of 6.5% and inflation below 2.5%), but it has been less granular with its thoughts about ending quantitative easing (or QE). This makes the monthly employment situation report the most important data point bond that market watchers will focus on.

 

MR-unemploymentEnlarge Graph

Highlights of the report

The economy added 148,000 jobs in September—lower than the consensus forecast of 180,000. August was revised upward to 193,000 jobs from 169,000. The unemployment rate fell to 7.2% from 7.3%, and the labor force participation rate remained the same at 63.2%—the lowest since 1978. Average hourly earnings increased 0.1% month-over-month and the average workweek was flat. Overall, the headline drop in the unemployment rate was encouraging, but the reason for the drop was not. After June’s torrid report, July, August, and September were a bit of a disappointment. The report caused rates to drop, which was a breath of fresh air for the REIT sector. The ten-year rallied 9 basis points on the report—a massive move.

Implications for mortgage REITs

After the Fed decided to maintain the pace of asset purchases at the September FOMC meeting, the ten-year rallied. This report, coupled with the fact that October will be worse due to the shutdown, means the Fed is probably on hold for the December meeting. Given that we’ll go through the whole shutdown and debt ceiling dance again early next year, the markets are thinking we won’t see any changes out of the Fed until the March meeting at the earliest.

The mortgage REIT sector has had a difficult time over the past three months. Rates have been increasing, as has volatility. We’ve seen large declines in book value per share as the sector struggles to de-leverage in a hostile environment. This sort of volatility gives mortgage-backed security investors conniptions. From what we’ve seen out of American Capital Agency (AGNC), maybe the bulk of the deleveraging is done, at least in the TBA sector.

Since rates started increasing, American Capital Agency (AGNC) is down 29% and Annaly (NLY) is down 25%. The REITs that focus on adjustable-rate mortgages, like MFA Financial (MFA) and Hatteras (HTS), have fallen less but are still down double-digit percentages. Where has the port in the storm been? The servicers like Nationstar (NSM) and Ocwen (OCN). They hold mortgage servicing rights, which increase in value as interest rates rise. Unsurprisingly, their stocks have risen since rates started going up.