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January Saw Unemployment Drop below 5%

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Highlights from the survey

In January 2016, the unemployment rate fell from 5.0% to 4.9%, or by about 7.8 million people. The underemployment rate was flat at 9.9%, and the labor force participation rate rose from multi-decade lows to 62.7%.

The underemployment rate includes discouraged workers or people who want to work but have given up looking. It also includes people marginally attached to the labor force and people employed part-time who want to work full-time.

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The number of people employed part-time for economic reasons (also referred to as “involuntary part-time employees”) was relatively unchanged at 6 million. So we’re seeing further improvement in the labor force—people are getting jobs—but there’s enough slack in the labor market that raises are still tough to come by. Later on in this series, we’ll talk about how that could be changing.

Influence on the Fed’s policy

The Fed has a dual mandate to maximize employment consistent with price stability. While the health of the labor market is partially indicated by the unemployment rate, it isn’t the only indicator that matters. In fact, the Fed had been using an unemployment target to guide its policy, but then it backed off as the target rate approached. The Fed found itself in a position in which the rule suggested it should raise rates, but the economy was nowhere near ready to handle higher rates.

The Fed’s language has thus shifted toward a more comprehensive view of the labor market. Investors interested in making directional bets on interest rates can look at the iShares Barclays 20+ Year Treasury Bond ETF (TLT).

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Implications for mortgage REITs

Changing unemployment is a double-edged sword for REITs (real estate investment trusts). Some REITs, particularly non-agency REITs, bear credit risk, and an improving economy is good news for them. Others, such as agency REITs, primarily bear interest rate risk, and they’re vulnerable to a hawkish Fed.

Levered agency mortgage REITs such as Annaly Capital Management (NLY), MFA Financial (MFA), and American Capital Agency (AGNC) are probably the most sensitive to short-term interest rates. The repurchase agreements they use to finance their balance sheets are fixed to LIBOR (Intercontinental Exchange London Interbank Offered Rate), which is heavily influenced by the federal funds rate.

On the other hand, non-agency mortgage REITs such as Two Harbors Investment (TWO) tend to use less leverage, so they’re less affected than others. Real estate companies such as Colony Financial (CLNY) are affected most by improving credit. Investors interested in broad exposure to the mortgage REIT sector may wish to look at the iShares Mortgage Real Estate ETF (REM).

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