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Why The Fed Continues To Anticipate Lower Unemployment

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The Fed released its economic forecasts

Usually, at the March, June, September, and December FOMC (Federal Open Market Committee) meetings, the Fed releases its economic forecast for the current year. It also releases its forecast for the next two years. This allows you to see how the forecast changed over time.

The Fed is decreasing its unemployment numbers for 2015

As you can see from the above chart, since its March 2013 meeting, the Fed has been lowering its estimates for unemployment in 2014. At the March 2013 meeting, the Fed was forecasting that 2015 unemployment would be 6.7%–7%. Now, the Fed is forecasting that unemployment will fall to 5.2%–5.3%.

The problem for the Fed is that the unemployment rate has been falling for the wrong reasons. It has been falling along with the labor force participation rate. The latest labor force participation rate of 62.8% was the lowest since the late 1970s. If unemployment is only shrinking due to the decreasing labor force, then it isn’t a sign of economic strength. This is why the Fed is now taking a more holistic approach to the labor market. It isn’t focusing on unemployment as the sole indicator.

One of the interesting topics that came out of the August FOMC minutes was staff economists’ opinion that there’s less slack in the labor market. This goes back to the issue of the labor force participation rate. Are the long-term unemployed ever going to return to the workforce? If they are, then that represents a reservoir of workers that will keep a lid on wage increases. However, if they’re more or less retired, then we may start seeing wage pressures sooner.

Implications for mortgage REITs

The unemployment rate affects the mortgage REITs in different ways.

For agency REITs—like Annaly (NLY) and American Capital Agency (AGNC)—this issue is more about when rates start increasing. These REITs invest in MBS (mortgage-backed securities). MBS are guaranteed by the Federal government. This guarantee means that MBS don’t have credit risk.

Non-agency REITs—like Redwood Trust (RWT), PennyMac (PMT), and Newcastle (NCT)—invest in MBS. They have credit risk. For them, unemployment matters in terms of the level of interest rates. It also matters in terms of loan performance.

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