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Why the FOMC Statement Is Constructive on the Economy

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Dec. 4 2020, Updated 10:52 a.m. ET

Language from the statement

The FOMC (Federal Open Market Committee) didn’t make many changes to its characterization of the economy.

The April statement said that “Information received since the Federal Open Market Committee met in March indicates that labor market conditions have improved further even as growth in economic activity appears to have slowed. Growth in household spending has moderated, although households’ real income has risen at a solid rate and consumer sentiment remains high. Since the beginning of the year, the housing sector has improved further but business fixed investment and net exports have been soft.”

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The March statement said that “Information received since the Federal Open Market Committee met in January suggests that economic activity has been expanding at a moderate pace despite the global economic and financial developments of recent months. Household spending has been increasing at a moderate rate, and the housing sector has improved further; however, business fixed investment and net exports have been soft.”

So, the labor markets are improving, economic growth slowed, and household spending moderated. However, the incomes and sentiment remain high. There wasn’t a change to housing, capital expenditures, and exports. On balance, it appears the Fed is still constructive on the economy.

We saw weakness in the first quarter for the past several years. Economists are beginning to wonder if we have a measurement problem or a seasonal adjustment problem. The economy appears to slow, yet many indicators (like labor) don’t confirm those numbers.

Adjusted growth estimates 

As you can see in the above chart, since its March 2014 meeting, the Fed has been lowering its estimates for GDP (gross domestic product) growth. At the March 2014 meeting, the Fed forecast that the GDP growth in 2016 would be 3.8%. In March 2015, it cut that forecast to 2.5%. The latest forecast lowered it even more to 2.3%. The Fed has been consistently too optimistic about economic growth since the recovery started.

Implications for mortgage REITs

Mortgage REITs are impacted differently by economic strength. Agency REITs like Annaly Capital (NLY) and American Capital Agency (AGNC) tend to react negatively to strength because it projects higher rates. Investors can trade though the iShares 20+ Year Treasury Bond ETF (TLT).

Mortgage origination-focused REITs like PennyMac (PMT) welcome strength. It helps increase the origination activity. Non-agency REITs like Two Harbors Investment (TWO) benefit from a more benign credit environment. Investors who are interested in trading the financial sector should look at the Vanguard REIT ETF (VNQ).

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