ANNALY CAPITAL MANAGEMENT INC

U.S. real economic growth improved in the second quarter relative to the first, as gross domestic product rose 2.8% on a seasonally adjusted annualized rate (“SAAR”). Despite the sound quarterly growth rate, consumer spending is moderating in 2024, rising 1.9% SAAR in the first six months of the year, somewhat less than the 3.1% SAAR expansion in the second half of 2023. Consumers appear to be increasingly cautious as elevated short-term interest rates, lower excess savings than immediately after the pandemic, low savings rates, a slowing labor market, and declining confidence appear to weigh on spending behavior. Investment activity appears to have been robust during the quarter outside of the residential sector, though forward-looking surveys do not appear to suggest this is a sustained increase in investment activity.

The supply and demand for labor has continued to move into better balance. According to the Bureau of Labor Statistics, seasonally adjusted total non-farm payroll employment rose 177,000 workers in the second quarter, well below the 276,000 workers added per month in the first quarter of 2024. The unemployment rate ended the quarter at 4.1%, the highest monthly reading since the fourth quarter of 2021 as more people entered the labor force, which expanded 114,000 individuals during the quarter, but ultimately were unable to find employment. At the same time, wage growth, as measured by the year-over-year change in Average Hourly Earnings, rose to 4.7% from 4.2% in the first quarter.

Inflation readings, as measured by the year-over-year changes in the Personal Consumption Expenditure Chain Price Index (“PCE”), remain above the Fed’s 2% inflation target and progress on disinflationary measures appears to have resumed following the firmer readings in the first quarter. Total PCE prices over the 12 months ended in June rose to 2.5% compared to the 2.7% recorded by the same metric in March, while core PCE inflation, which excludes volatile food and energy prices, fell from 2.8% in March to 2.6% in June. Price pressures eased in several services, including transportation and recreation services, as airline fares and live event pricing pressures eased somewhat. The most positive inflation development, however, was a slowdown in the pace of shelter inflation predominantly in June, which suggests a further slowdown in the aggregate inflation could continue given the large importance of shelter inflation and the lagged, slow-moving methodology used to incorporate shelter inflation into the headline index.

The Fed conducts monetary policy with a dual mandate: full employment and price stability. The Federal Reserve Open Market Committee (“FOMC”) has kept the target range for the Federal Funds rate unchanged at the restrictive level of 5.25% - 5.50% since July 2023. The Fed Chair Jerome Powell has stated that the policy rate is at its peak in the Fed’s tightening cycle. The FOMC has committed to a data-dependent policy approach and recent economic data of softer inflation and labor market data have suggested that interest rate cuts could commence in the second half of 2024. Forecasts from the FOMC meeting in June show the median forecast of the FOMC expects just one 25 basis point interest rate cut this year, though interest rate markets expect slightly more than two such cuts. Meanwhile, regarding the FOMC’s balance sheet policy, the decline in their securities portfolio, which started in 2022, continued throughout the second quarter, though the FOMC has slowed the pace of decline in the Treasury portfolio from $60 billion per month to $25 billion per month to limit risks of financial market stress, particularly in front-end money markets.

Interest rate levels rose during the second quarter, however, the move was gradual and interest rate volatility moved lower relative to the second half of last year. The 10-year U.S. Treasury rate increased from 4.20% on March 31 to 4.40% on June 30, 2024. Higher rates and continued above-average interest rate volatility led the mortgage basis, or the spread between the 30-year Agency MBS coupon and 10-year U.S. Treasury rate, to widen modestly from 140 basis points to 147 basis points over the same period.

The following table presents interest rates and spreads at each date presented: