How much slack is there in the labor market?



The FOMC staff assesses the labor market

The Federal Open Market Committee (or FOMC) staff is basically a team of academic researchers who compile and analyze economic data for FOMC participants. Overall, members of the staff noted that the labor market continued to improve moderately. They noted that the unemployment rate continued to fall, the number of people who are involuntarily employed part-time fell, and the labor force participation rate continued to tick up. Currently, however, they have yet to see much evidence of wage growth.

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Are we stuck between leading and lagging indicators?

One of the biggest difficulties in assessing the state of the labor market is separating the leading indicators from the lagging indicators. The economic data we typically associate with the labor market, unemployment and wages, are usually lagging indicators. This means that as conditions improve or deteriorate in the labor market, wages and unemployment are the last indicators to confirm what’s happening. Unemployment has been falling, although that has been driven by a decline in the labor force participation rate. Wage growth has been ever so slightly higher than inflation. The lagging indicators are signaling no major improvement in the labor market.

The leading indicators of the the labor market, however, are flashing bright green. Weekly Initial Jobless Claims have been hitting consistently below 300,000, a level normally associated with boom-time levels. Job Openings, as measured by the JOLT (Job Openings and Labor Turnover) job survey, are also at boom-time levels. These data indicate the job market is in a transition period and is about to accelerate.

Implications for mortgage REITs

Wage inflation is probably the biggest indicator the Fed is concerned about at the moment. Once it starts seeing evidence of wage inflation, it will start hiking rates, and it may do so even before seeing wage inflation. This would be negative for mortgage REITs such as Annaly Capital Management (NLY), American Capital Agency (AGNC), MFA Financial (MFA), and Capstead Mortgage (CMO).

Even if long-term rates stay supported by overseas weakness, increases in short-term rates mean higher borrowing costs. This will lower net interest margins and could put pressure on dividends. Investors who want to trade interest rates directly should look at the iShares 20-year bond ETF (TLT).


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