Housing Inflation is Too High
Inflation is still too high, and the cost of housing is largely to blame.
The Federal Reserve decided to keep their interest rate target unchanged last week. Just 5 months ago, market participants were pricing in as many as seven 0.25% rate cuts in 2024. Today, that expectation has fallen to under 2.
What’s changed? It’s persistent inflationary pressures. Here’s a look at the Consumer Price Index over the last 15 years. Throughout the 2010s, inflation was largely a non-factor as prices oscillated around the Fed’s 2% annual target. That all changed in 2020, when stimulus-fueled demand for goods met a supply chain snarled by pandemic restrictions. CPI surged to nearly 9% - the highest rate since the early 1980s.
As supply chains were repaired and stimulus wore off, inflation began to moderate in the second half of 2022 and throughout 2023. And by the end of last year, it seemed things were well in hand. Soon, the Fed would have the confidence it needed that inflation was moving sustainably toward 2 percent, and that would allow them to reduce the target rate for the federal funds rate.
But the CPI this year has stopped normalizing and instead stabilized above 3%.
In the words of Fed Chair Jerome Powell, “We didn't see progress in the first quarter, and I've said it appears then that it's going to take longer for us to reach that point of confidence. So I don't know how long it'll take.”
Fortunately for Mr. Powell, achieving the 2% inflation target by the end of 2024 is still possible. All it would take is for shelter inflation to follow its expected path.
Here’s Mr. Powell from back in November 2022 explaining the dynamics of measuring shelter prices: “Housing inflation tends to lag other prices around inflation turning points, however, because of the slow rate at which the stock of rental leases turns over. The market rate on new leases is a timelier indicator of where overall housing inflation will go over the next year or so.”
There are plenty of third-party providers we can use to look at the market rate on new leases - Zillow, ApartmentList, and Redfin all provide versions of that data - but if we’re trying to chart the future path of the CPI, why not go straight to the source of the CPI itself? The Bureau of Labor Statistics is here to help:
“The rent component of the official CPI measures the change in all rents, including new leases, renewals, and rents in the middle of a lease. In contrast, the New Tenant Rent Index uses only a subset of the data the official CPI uses, namely the first survey observations after new tenants move into their sampled housing units. The All Tenant Regressed Rent Index measures the rent paid by all renters, both new and continuing, and incorporates most of the survey data used for the CPI Rent of primary residence index.”
Take a look below at the New Tenant vs. All Tenant Rent indexes over the last 20 years. The post-pandemic period stands out, when the growth rate on New Tenant Rents accelerated at an unprecedented rate. As Powell noted above, the All Tenant Rent index lagged on that initial acceleration. Likewise, though New Tenant Rent has stabilized over the last year, All Tenant Rent has barely slowed.
The post-pandemic dislocation was so large that we’ve just been playing catch-up for the last year. Now it’s time for the growth rate to catch-down.
We wondered how much of a tailwind Powell & Co. might get over the rest of the year, so we set about trying to quantify it.
Since the average renter in the US stays put for a little over two years, that means taking a two-year average of New Tenant Rents should give us a pretty good idea of where the All Tenant Rent is at any given time. And that’s exactly what we see. Check out the year-over-year change in the 8-quarter average of New Tenant Rents and compare it the the y/y change in All Tenant Rents. They track almost perfectly.
We took it one step further. We extrapolated the New Tenant Rent Index over the next few quarters (using seasonal pattern of the last 20 years) to project where the 8Q average might end up by year-end. The result? A sub-1% growth rate.
That’s good news for the future of Shelter inflation in the CPI, because Shelter inflation tracks closely with both the change in All Tenant Rents and the 8-quarter average of New Tenant Rents.
What might that mean for Mr. Powell and his 2% inflation target? We won’t go so far as to say he’s destined for success - we’re not economists, and we do our best to avoid making economic predictions. We can do basic math, though. The difference between 5.6% inflation and 1% inflation on a component that has a 36% weight in the CPI comes to a 1.6% change at the index level.
With inflation today at 3.5%, it’s not hard to see a path to 2%.
That’s all for today. Until next time.