The Fed Reduced Its Forecast for 2016 Unemployment
Bonds Barely React to the December 2015 FOMC Minutes
The Fed’s discussion of the labor market
After the December FOMC meeting, the Fed forecast that 2016 unemployment would come in at 4.6%–4.8%, a fall from its September forecast of 4.7%–4.9%.
The Fed staff noted that improvement in the labor market appeared to continue and gather momentum in the inter-meeting period. October and November payrolls expanded at a faster rate than they did in the third quarter. The labor force participation rate and the employment-to-population ratio also rose.
Compensation was characterized as “mixed,” with compensation per hour rising 3.5% while the employment cost index rose at 2%. Average hourly earnings rose 2.3% and have been accelerating recently.
The Fed members noted the improvement in the labor market, and their fears of a slowdown abated somewhat. That said, the labor market has some strange numbers. Unemployment remains low, yet the labor force participation rate is at nearly 40-year lows. There was debate on how much slack was left in the labor market. Some believe that we have used up almost all of the slack in the labor market while others believe we have further to go to get to full employment. Note that historically the Fed has used 5%–5.5% as a rule of thumb for “full employment.”
Implications for mortgage REITs
Wage inflation is the biggest indicator the Fed is concerned with at the moment. Once it starts seeing evidence of wage inflation, it will start raising rates, and it may do so even before seeing wage inflation. This would be negative for mortgage REITs such as Annaly Capital Management (NLY), American Capital Agency (AGNC), and MFA Financial (MFA). On the other hand, wage inflation is good news for non-agency REITs such as Two Harbors Investment (TWO) as it takes credit risks.
Even if long-term rates remain supported by overseas weakness, rises in short-term rates mean higher borrowing costs. This would lower net interest margins and could put pressure on dividends. Investors who want to trade interest rates directly can look at the iShares 20+ Year Treasury Bond ETF (TLT). Investors who are interested in trading the financial sector as a whole can look at the S&P SPDR Financial ETF (XLF).
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