Bimini Capital Management, Inc. (BMNM)

[alexander77]

Why subdued employment costs are good for mortgage REITs

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

The Employment Cost Index (or ECI) is prepared quarterly by the Bureau of Labor Statistics. It’s the counterpart to the Consumer Price Index (or CPI). One way of thinking about ECI is that it’s the wage side of the wage-price spiral, while CPI is the price side. The Employment Cost Index is used as 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. Wages growth has been generally subdued since the Great Recession began and benefits, specifically health insurance, has increased.

Highlights of the report

Employment costs increased 0.4% in the quarter ending September 30, flat from the 0.4% increase in the fourth quarter of 2012. Wages and salaries (which account for 70% of the index) increased 0.3%, while benefit costs increased 0.7%, an increase from the 0.4% jump in the third quarter of 2012.

Over the past 12 months, compensation costs for civilian workers increased 1.9%. Wages increased while benefit costs increased 1.6%. For private industry workers, compensation increased 1.7%, while benefits increased 2.2%. For government workers, compensation costs increased 1.7%, while benefit costs increased 2.9%.

In terms of industries, wages and salaries in finance were up 0.5%, as was construction. The laggards were in retail and hospitality, which were up 0.1%. Geographically, the South and West increased 2%, while the Midwest and Northeast increased 1.7%.

It will be interesting to see the effects of the Affordable Care Act on employment costs. We’ll find that out in the March 2014 report.

Impact on mortgage REITs

Historically, the Fed closely watched the Employment Cost Index, and 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 it higher. 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 and the Fed will probably continue asset purchases (quantitative easing). This means that mortgage yields will be low, leverage will be required to generate a return on equity, borrowing costs will remain low, and prepayment risk will remain a threat. Prepayment risk stems from the fact that a borrower can refinance their mortgage without penalty. So if interest rates drop, the mortgage investor will find their highest-yielding mortgages paid off early and they will be forced to re-invest the money in lower yielding mortgages.

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http://finance.yahoo.com/news/why-subdued-employment-costs-good-174558355.html