Implications of the September FOMC Minutes for REIT Investors

(Continued from Prior Part)

The Fed’s discussion of the labor market

After the September FOMC meeting, the Fed forecast that 2015 unemployment would come in at 5.0% to 5.1%, a decrease from its June forecast of 5.2% to 5.3%. The committee members characterized job growth as “solid” in the inter-meeting period, and noted that unemployment had fallen to 5.1%. Also, the percentage of people working part time fell as well, which presumably means people are switching from part time to full time.

Overall, the amount of under-utilization in the labor force has fallen over the year. On the negative side, wage inflation remains subdued, and the labor force participation rate remains mired at close to 40-year lows.

The committee noted that labor market conditions had “improved considerably” since January and under-utilization of labor resources had diminished. Some members noted anecdotal evidence from their own industry contacts that firms were concerned about employee retention and were having trouble finding skilled labor.

The committee said that in order to reduce some of the under-utilization of labor resources, it might be appropriate to leave unemployment below its target level temporarily to eliminate slack in the labor market. In fact, some said that this could actually help the Fed achieve its target of 2% inflation earlier than it otherwise would. This language about running the economy for some time with the unemployment rate below its “natural” rate of unemployment was new, and it was what got the market’s attention. The Fed essentially is willing to let the economy run hot for a while.

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 hiking rates, and it may do so even before seeing wage inflation. This would be negative for mortgage REITs such as Annaly Capital Management (NLY) and American Capital Agency (AGNC). On the other hand, wage inflation is good news for non-agency REITs like Two Harbors (TWO) that take credit risks.

Even if long-term rates stay supported by overseas weakness, increases in short-term rates mean higher borrowing costs. This will lower net interest margins and could put pressure on dividends. Investors who want to trade interest rates directly should look at the iShares 20-Year Bond ETF (TLT). Investors who are interested in trading the financial sector as a whole should look at the S&P SPDR Financial ETF (XLF).