Unemployment is dropping, so why don’t people feel better about the economy?
The unemployment rate is the most important data point out there right now, and it’s been falling. So why doesn’t the average citizen feel better about the economy? The reason is the labor force participation rate.
To be considered unemployed, you have to make an effort to get a job. If you haven’t done anything in the prior month, you’re no longer considered unemployed. As far as the government is concerned, you’ve dropped out of the labor force. Of course, you are still unemployed. But for the purpose of the official unemployment rate, you are not.
The labor force participation rate
The labor force participation rate is the ratio of the labor force against the demographic cohort. In other words, it’s similar to the employment-to-population ratio the Fed uses, but it takes demographics into account.
As you can see from the chart above, the labor force participation rate increased steadily from the early 1960s through the early 2000s as more women entered the labor force. Since the Great Recession, however, the labor force participation rate has declined. It’s back to levels we haven’t seen since the late 1970s.
In June, the labor force participation rate ticked down to 62.6%, which is the lowest since 1977. To put the change in the labor force participation rate into perspective, roughly half the gains that were attributed to women entering the labor force, starting in the 1960s, have been given back. This is one of the biggest reasons the economy remains sub-par. Yes, Baby Boomers are retiring, but the Millennial generation is larger and is having trouble replacing them.
Implications for mortgage REITs
The open question for REITs and the Fed is whether these discouraged workers, particularly at the older end of the spectrum, are ever coming back into the labor force. This is the key question the Fed is facing right now.
On the one hand, shrinking the size of the available labor pool will put upward pressure on wages at the margin. The offset is that unemployed or early-retired Baby Boomers won’t be spending much. How this shakes out for inflation remains to be seen. Note that the latest NFIB Small Business Survey reported that companies are having a difficult time finding qualified workers.
If we see inflation make its way back, it will be the most negative for mortgage REITs with large levered portfolios of agency mortgage-backed securities, especially Annaly Capital Management (NLY) and American Capital Agency (AGNC). These two are the most vulnerable to increasing inflation. Inflation will drive long-term rates higher, which investors can trade via the iShares Barclays 20+ Year Treasury Bond Fund (TLT).
Non-agency REITs like Two Harbors (TWO) will actually benefit somewhat from moderate inflation, since it generally boosts real estate prices and helps out debtors. Increasing real estate prices are generally good news for REITs that focus on origination, such as Nationstar Holdings (NSM).
Investors interested in gaining exposure to the mortgage REIT sector can consider the iShares Mortgage Real Estate ETF (REM).