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Employment Cost Index Falls

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The Employment Cost Index measures the cost of labor to business

The Bureau of Labor Statistics prepares the US Employment Cost Index, or ECI, quarterly. The index is the counterpart to the Consumer Price Index, or CPI. One way of thinking about the ECI is that it’s the wage side of the wage-price spiral, while the CPI is the price side.

The ECI is an input into government salaries and is often cited by the Federal Reserve when it sets policy. Investors interested in making directional bets on interest rates should look at the iShares Barclays 20+ Year Bond Fund (TLT).

Employment costs increased 0.2% in the quarter ending June 30, 2015. This was a small increase from the fourth quarter of 2014. Wages and salaries, which make up about 70% of the index, increased 0.2%, while benefit costs increased 0.1%.

Over the past 12 months, compensation costs for civilian workers increased 2.0%, while benefit costs increased 1.8%. For private industry workers, wages and salaries increased 2.2%, while benefits increased 1.4%.

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The Obama administration recently increased employment costs by having the Department of Labor mandate time-and-a-half overtime pay for workers who had previously been classified as managerial. He also required federal contractors to offer paid sick leave over the Labor Day weekend. This will only raise costs and decrease productivity further.

Impact on mortgage REITs

If benefit costs are rising faster than wages and salaries, then workers are becoming more expensive. However, they’re not receiving the full benefit of that increase. This increases employment costs, but you won’t see a big uptick in consumption. Note that unit labor costs increased 6.7% in the first quarter as productivity declined. This is bearish for future wage growth.

The REITs most exposed to this are non-agency REITs such as Two Harbors Investment Corp (TWO), because they invest in mortgage-backed securities, or MBSs, that are not backed by the federal government. Others exposed to this are REITs with large portfolios of mortgage-servicing rights, or MSRs, such as Nationstar Mortgage Holdings (NSM).

Servicers are required to make principal and interest advances to security holders, even if the borrower doesn’t pay. They can find themselves with cash flow problems if there’s a big shock. In fact, after the financial crisis, big agency REITs such as Annaly (NLY) and American Capital Agency (AGNC) rallied, while REITs with large MSR portfolios got hammered.

Investors who would like to trade in the mortgage REIT sector should look at the iShares Mortgage Real Estate ETF (REM).

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