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Dallas Fed bounces back in May


Nov. 20 2020, Updated 3:29 p.m. ET

The Dallas Fed Manufacturing Index is a manufacturing-focused index of business activity

The Dallas Fed conducts its Texas Manufacturing Survey monthly, and it is similar to many of the other regional Fed surveys, like the Empire State Manufacturing Survey, the Chicago Fed National Activity Index or the Philly Fed. These are all diffusion type indices in which respondents are asked whether a certain metric is increasing, decreasing, or staying the same. The percentage of people responding with a decrease is subtracted from the number of people reporting an increase to come up with the results. In other words, if businesses are asked about their hiring plans, and 30% say they intend to add to payroll, 45% say they are holding steady, and 25% say they are decreasing payroll, the index would be 30 – 25 = 5.  That is generally how all diffusion indices work.

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The Dallas Fed survey asks about output, employment, orders, prices, shipments, inventories, capacity utilization, prices, capital expenditures, and some other indicators. Respondents are also asked for their six month outlook and are usually asked about a subject in depth. This month it was healthcare related.

Highlights of the survey

The Broader Business Conditions Index rebounded in May to -10.5 from -15.6 in April, which was the lowest level since July of 2012. Overall, it looks like growth in manufacturing rebounded in May. Production increased from -0.5 to 11.2. Capacity Utilization increased to 6.4 from 2.7 and shipments rose to 3.1 from -0.4 in April. As we have seen with other Fed surveys, prices paid increased as prices received fell. This shows that manufacturers are reluctant to pass on raw material price increases to customers.

On the labor front, the index turned negative, with 8% of firms reporting hiring new workers while 15% had layoffs; compensation remained flat and hours worked fell. The six month outlook fell slightly but remained in positive territory.

Impact on Mortgage REITs

Interest rates are the biggest driver of mortgage REIT returns, and nothing in this report would encourage the Fed to change from their current course. That said, Ben Bernake’s testimony in front of Congress gave the market a hint that the Fed might begin tapering asset purchases this Fall. As the 10-year bond has sold off, mortgage REITs, like Annaly (NLY), American Capital (AGNC), MFA Financial (MFA) and Hatteras (HTS), have under-performed.

Increasing rates are a double edged sword for the REITs. On one hand, continued low rates mean their cost of leveraging their portfolio is low, but on the other hand they take mark-to-market hits on their portfolio even as interest margins increase. Although increasing rates will decrease prepayment risk for the REITs, increasing real estate prices would allow some FHA borrowers to refinance into a conforming mortgage and save on mortgage insurance payments. Prepayments will negatively affect the mortgage REITs as they are forced to reinvest into lower yielding paper.

The continued volatility in the bond market will negatively affect mortgage REITs as mortgage backed securities generally perform best in a stable interest rate environment.


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