No shelter for the Fed

Economy News


Nick Mazing is head of research at financial intelligence platform Sentieo. In this post, he explains why the CPI for shelter is set to add to the problems facing Federal Reserve chair Jay Powell.

When the Federal Reserve’s monetary policymakers sit down later this week to discuss how to tackle the surge in US inflation, the recent moves in the price of energy will feature prominently.

That’s clearly important. The invasion of Ukraine has triggered a fresh surge in shiny rocks, black goo and air you burn. To boot, Americans care more than most what they pay at the pump – it is a nation built around the automobile.

But the Fed’s travails do not begin and end with what’s happening to gas prices. In the coming quarters, officials are set to face price pressures from another essential item for consumers: housing.

The housing component of the Consumer Price Index, or CPI, accounts for just over 42 per cent of the weight of goods and services in the “inflation basket” used to calculate the rate of change in prices in the US. That’s a far higher portion than energy.

Shelter, specifically, is over 33 percent of the basket. Breaking it down further, rent of primary residence is 7,862 per cent and owners’ equivalent rent is 24,263 per cent.

So what’s happening to housing costs right now?

The measures of consumer price inflation that the Fed relies upon are already at multi-decade highs. The reading for shelter currently comes in at 4.7 per cent – much higher than monetary policymakers might like. Yet even that figure underestimates what’s actually happening in the housing market.

On the chart below the red line is the year-on-year per cent change in the S&P / Case-Shiller 20-city composite home price index, which measures year-on-year changes in house prices. The blue line is the official CPI inflation figure for shelter.

Quite the discrepancy.

Online broker Redfin, meanwhile, reported that median home sale price in February 2022 was up 16 per cent compared with a year ago, while the monthly mortgage payment on the median asking price was up 23 per cent compared with the prior year, and up 36 per cent compared with the same period in 2020. Redfin previously reported that January 2022 was “the most competitive month on record” for homebuyers, with 70 per cent of home offers facing competition.

This underestimation of shelter inflation also holds for rents. We’ve been looking closely at the rental rates reported by publicly traded residential REITs. They are also seeing mid-teen increases, year-on-year, based on their reporting for the fourth quarter of last year.

Here are some examples from big players in the market. Mid-America Apartment Communities, with ownership interest in over 100,000 units across 16 states, reported a 16 percent increase year-on-year on a “blended” basis – that is, new leases and renewals. Essex Property Trust, with ownership interest in over 60,000 units, reported a 13.9 per cent “blended” rate rise. Camden Property Trust, with ownership interest in over 58,000 units, reported a 15.7 per cent “blended” rise. Invitation Homes, which focuses on single family home rentals and has ownership interest in over 82,000 homes, reported a “blended” rise of 11.1 per cent. Similarly, Redfin’s latest rental data release showed a 15.2 per cent year-on-year increase for January 2022, with the Top 10 out of their Top 50 metro areas recording annual increases between 31 per cent and 39 per cent.

So what explains the discrepancy?

Let’s look at the methodology behind the CPI calculation.

As touched upon earlier, to measure shelter the Bureau of Labor Statistics uses two distinct indices: the OER (owners’ equivalent rent of primary residence) and Rent (the rent a lessee pays on their residence).

The data for each index is collected from six samples of housing units. But each sample group is only surveyed once every six months.

The rationale is that rents change less frequently than other goods and services in the CPI. However, in times of faster price increases, these data points are, in effect, “old news,” and not as reflective of the real market as what we can observe in the reports of the housing REITs.

What adds to the complexity of this specific index component is that housing is a widely-owned asset: over 65 per cent of US households own their home, and about 60 per cent of owner households have a mortgage, with the balance owning their houses outright . The BLS itself views houses as capital goods rather than consumption items which is why house price changes are not directly reflected in the index.

The official numbers are yet to reflect the reality of double-digit housing inflation for aspiring homeowners or people who rent. But we suspect that the large shelter component of the CPI will rise in the coming quarters. Even if other parts of the CPI ease, this will keep the pressure on the Federal Reserve to carry on raising rates.

A 25 basis point rise this week looks a certainty, with further hikes later this year a sound bet too.

The only “good” news for Powell and co is that they have the tools to cool the housing market. While the US has a chronic lack of housing supply, tighter credit conditions should help. Even if it does not completely solve the problems facing aspiring homeowners and renters, the Fed has far more control over conditions in the market for mortgage credit and, indirectly, rents than it does over oil prices.



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