FOMC Finally Sees Improvement in the Labor Market



Fed discussed the labor market in the July FOMC statement

Let’s compare the Fed’s statements in June and July regarding the state of the labor market.

The July FOMC (Federal Open Market Committee) statement said that “Information received since the Federal Open Market Committee met in June indicates that the labor market strengthened and that economic activity has been expanding at a moderate rate. Job gains were strong in June following weak growth in May. On balance, payrolls and other labor market indicators point to some increase in labor utilization in recent months.”

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The June FOMC statement said that “Information received since the Federal Open Market Committee met in April indicates that the pace of improvement in the labor market has slowed while growth in economic activity appears to have picked up. Although the unemployment rate has declined, job gains have diminished.”

The Fed noted the huge rebound in payrolls after the dismal May reading. May’s numbers were depressed by a Verizon strike as well as some technical issues related to seasonality. Those issues were unwound in June. If you take the average of the two months, it’s a more accurate description of the labor market—moderate growth, but nowhere near overheating.

Fed has been decreasing its unemployment forecast

As you can see from the above chart, since its March 2014 meeting, the Fed has been lowering its estimates for unemployment in 2016. At the June 2014 meeting, the Fed forecast that unemployment would be 5.3% in 2016. At the June 2015 FOMC meeting, it forecast 5%. At the June 2016 meeting, the Fed maintained its forecast at 4.7%

This raises the question about what the Fed considers the “non-accelerating inflation rate” of unemployment. Although 5% has historically been considered the accurate level, the Fed apparently thinks it’s lower. Fed Chair Janet Yellen mentioned that the Fed intends to let the labor market run hot for a while in order to try and encourage wage growth.

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Implications for mortgage REITs

The unemployment rate impacts mortgage REITs in different ways. For agency REITs—including Annaly Capital (NLY), American Capital Agency (AGNC), and MFA Financial (MFA)—the issue is more about the timing of rate hikes. These REITs invest in mortgage-backed securities that are guaranteed by the federal government. They’re very sensitive to rates, but they aren’t sensitive to credit. Investors who are interested in making directional bets on interest rates should look at the iShares 20+ Year Treasury Bond ETF (TLT).

Non-agency REITs—including Redwood Trust (RWT), PennyMac (PMT), and Newcastle (NCT)—invest in mortgage-backed securities that aren’t guaranteed by the federal government. They’re split between bearing interest rate risk and credit risk. For them, decreasing unemployment is a double-edged sword. Better labor markets improve loan performance, but they make rate hikes more likely. Investors who are interested in trading the REIT sector should look at the Vanguard REIT ETF (VNQ).


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