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Employment costs are ticking up: Impact on mortgage REITs

August 2014's labor releases are essential for REIT investors (Part 5 of 6)

(Continued from Part 4)

The Employment Cost Index is a quarterly index that measures the cost of labor to business

The Employment Cost index (ECI) is prepared quarterly by the Bureau of Labor Statistics. It’s the counterpart to the Consumer Price Index (CPI). One way of thinking about ECI is that it is the “wage” side of the wage-price spiral, while CPI is the “price” side.

The Employment Cost Index is an input into government salaries and is often cited by the Federal Reserve when setting policy.

The ECI breaks out the cost of private and public sector workers, including changes in compensation and benefits. The results are further broken down into occupational groups. The biggest use of the ECI is to identify wage-push inflation. Wage growth has been generally subdued since the Great Recession began and benefits—specifically health insurance—have increased.

Employment costs increased 0.7% in the quarter ending June 30. This was slightly higher than the 0.4% increase we saw in the first quarter of 2013. Wages and salaries increased 0.6%, while benefit costs increased 1%. This was a 0.6% jump from the first quarter. It’s too early to tell if the Affordable Care Act is pushing up labor costs.

Over the past 12 months, compensation costs for civilian workers increased 1.8% while benefit costs increased 2.5%. For private industry workers, compensation increased 1.9%, while benefits increased 2.4%. For government workers, compensation costs increased 1.3%, while benefit costs increased 3.2%.

Impact on mortgage REITs

Historically, the Fed closely watched the Employment Cost Index. Surprises in the index could move the bond market. These days, the Fed isn’t all that concerned about inflation raging out of control. Indeed, it would like to see higher inflation.

There’s nothing in this report to indicate that employee compensation costs are going to trigger a wage-price spiral. Given the slack in the labor market and the high unemployment rate, it’s almost impossible for wages to rise meaningfully nationally.

The takeaway for mortgage REITs like Annaly (NLY), American Capital (AGNC), Capstead Mortgage (CMO), Chimera (CIM), and Two Harbors (TWO) is that interest rates will remain low for the time being and we probably won’t see evidence of inflation until wage inflation reaches close to 5%.

Continue to Part 6

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