E Economics

U.S. CPI’s Shelter Inflation YoY Should Reach A Top Soon

24 August, 2022

Academic research showed that Fed measures to assess the dynamic of the U.S. rental market, such as the shelter component of the Consumer Price Index (and also PCE price index), tend to lag market rents. This delay — explained by data construction and multiple methodological weaknesses — suggests that the recent deceleration of market rents’ growth (YoY) will impact Fed favourite measures (shelter inflation) in the coming months.

1. Market Rents’ Growth (YoY) Reached A Turning Point, Decelerating Over the Past Few Months

Last year, I highlighted many times that inflation shock wasn’t transitory or episodic. Among other factors, I flagged that the shelter component of the CPI (~32% of the index) will accelerate sharply, then forcing employees to ask for pay hikes and therefore creating a wage-price spiral. As expected, Fed policymakers reacted agressively (but too late despite warnings since early 2021). This reaction surprised market participants and has led to a significant countershock, namely a housing recession. In this context, all indexes from private data providers (Corelogic, Real Page, Redfin, Apartment List, Yardi) showed that market rents’ growth (YoY) already peaked.

2. Fed Measures To Assess The Dynamic Of The Rental Market Tend To Lag Market Rents

Economists have observed that Fed measures to assess the dynamic of the rental market tend to be “sticky” relative to market-based rental costs and also lagged them during expansionary periods. This pattern can be explained by several factors such as data construction and multiple methodological weaknesses. As a result, it seems that market rents reflect housing market turning points sooner and could allow the Federal Reserve to be more responsive to housing shifts.

More precisely, the CPI’s measure of rents for homeowners has typically lagged other measures of market rents by between nine and 12 months. Therefore, given that private data suggest that market rents’ growth (YoY) already reached a top, CPI’s Shelter Inflation YoY should follow soon, particularly in a context where housing prices started retracing for the first time since 2012!