Initial jobless claims remain volatile but it’s just seasonal noise

Initial jobless claims decreased to 338,000 for the week ended December 20

Initial jobless claims are one of the few labor market indicators released every week. Unemployment is a profound driver of economic growth, and persistent unemployment has been the Achilles’ heel of this recovery. While it seems like the big layoffs are largely finished, firms are still reluctant to add staff aggressively. Aside from the Hurricane Sandy–influenced spike in late October, initial jobless claims have been holding steady in the 340,000-to-380,000 range.

Initial Jobless ClaimsEnlarge Graph

Historically, real estate prices have tracked very closely with incomes. In fact, up until the real estate bubble burst, the ratio of median home price to median income remained in a relatively tight range of 3.2x to 3.6x. So if unemployment is rising, there’s little upward pressure on wages, which tends to be negative for home prices. Plus, the unemployed are unable to qualify for a mortgage, so the pool of buyers shrinks.

Initial jobless claims rise, but there may be distortions

We recently had sub-300,000 print on initial jobless claims this year, which was the lowest since May 2007. This large level seems to be an aberration, showing the hiring fluctuation that usually goes on around the holidays.

That said, the financial industry is laying people off as the mortgage business dries up. Also, as we saw from the Challenger and Gray Job Cut announcement, the defense and retail sectors are laying people off to reduce costs.

Before the housing bust, initial jobless claims averaged around 356,000 from 1990 to 2007. This doesn’t indicate a healthy economy, where claims are below 300,000. Given that some of the economic indicators are starting to turn downward, initial jobless claims may rise again.

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 delinquencies and defaults can influence returns. The unemployment rate is by far the biggest driver of defaults. Agency REITs—such as Annaly (NLY) or American Capital Agency (AGNC)—that invest in Ginnie Mae (government-guaranteed) or conforming (Fannie Mae, government-sponsored) mortgage-backed securities consider defaults to be just a different type of prepayment. Typically, the higher-coupon loans have default issues, and once the loans become 90-days delinquent, the lender purchases them out of the pool and repays them at par. This lowers returns for the portfolio going forward.