The Fed may have a housing problem. At least there's the mystery of housing.
Overall inflation has eased significantly over the past year. But housing turned out to be a persistent and surprising exception. According to the Department of Labor, shelter costs rose 6% in January compared to the same month a year ago, and on a monthly basis, the rate of increase was faster than in December. This acceleration was a major reason for the rise in overall consumer prices last month.
Persistent housing inflation is a problem for Fed officials as they consider when to cut interest rates. Housing costs are by far the largest monthly expense for most families, and therefore contribute significantly to inflation calculations. Unless house prices cool down, it will be difficult for overall inflation to return sustainably to the central bank's 2% target.
“If you want to know where inflation is going, you need to know where housing inflation is going,” said Mark Francesky, managing director of housing research firm Zelman & Associates. He added that housing inflation “hasn't slowed down as fast as we expected or anyone expected.”
These expectations are based on private sector data provided by real estate websites such as Zillow and Apartment List and other private companies, which show that rents have barely increased recently and in some markets have fallen completely. It is shown that there is.
For homebuyers, a combination of rising prices and high interest rates are making housing increasingly unaffordable. Meanwhile, many existing homeowners are partially insulated from rising prices because they have fixed-rate mortgages where payments don't change every month.
However, house prices and mortgage interest rates are not directly reflected in inflation data. That's because buying a home is an investment, not just a consumer purchase like groceries. Instead, inflation data is based on rents. Private-sector data also shows a slowdown in rents, and economists expect the slowdown to show up in government data as well.
Federal Reserve officials largely dismissed housing inflation for much of last year, believing that official statistics were simply slow to reflect the cooling trend evident in private data. Instead, they focused on measures that excluded shelters, believing that approach better reflected underlying trends.
But as the divergence continues, some economists inside and outside the Fed are beginning to question these assumptions. Economists at Goldman Sachs recently raised their forecast for housing inflation this year, citing rising rents for single-family homes.
“There's clearly something going on that we don't understand yet,” Chicago Fed President Austan Goolsby said in a recent interview. “They ask me, 'What are you looking at?'” I said, “What are you looking at?” “We’re focusing on housing because it’s still a strange thing. ”
delayed data
The stubborn nature of housing inflation is not entirely a mystery. Economists knew that the rent restraints seen in private sector data would take time to be reflected in the Labor Department's official consumer price index.
There are two reasons for that delay. The first is technical. The government's data is based on monthly surveys of thousands of rental homes. However, inspections of a particular unit are carried out only once every six months. So if an apartment is inspected in January and the rent increases in February, that increase will not be reflected in the data until the apartment is inspected again in his July. This means that government data lags behind the situation, especially during times of rapid change.
The second reason is conceptual. Most private indexes only include rentals if you acquire a new tenant. However, the government aims to collect housing fees from all tenants. Because most leases last more than a year and people who renew leases often receive discounts compared to those who rent on the open market, government data is typically adjusted more gently than private indicators.
Public and personal data should eventually be integrated. But it's not clear how long that process will take. For example, rents skyrocketed in 2021 and 2022, prompting many people to stay put rather than step into the increasingly competitive rental market. Among other factors, market rents may have taken longer than usual to be reflected in government data.
There are signs that a slowdown is underway. Over the past three months, rents have been rising at an annual rate of less than 5%, down from a peak of nearly 10% in 2022. While private data sources disagree on how much rent inflation needs to be eased, they do agree on the trend. You should continue.
“For the most part, they're all saying the same thing, which is that rent inflation has eased significantly,” said Laura Rosner-Warburton, senior economist at economic research firm MacroPolicy Perspectives. ” he said.
House vs apartment
Rental inflation may finally be calming down, but the government's cost measurements for homeowners aren't following suit. It actually accelerated in the latest month's data. And because more Americans own homes than rent, homeowners make up the majority of the shelter component of the consumer price index.
Expenses that most people associate with homeownership, such as mortgage payments, homeowner's insurance, and maintenance and repairs, are not directly included in the inflation measure.
Instead, the government measures owner-occupied housing inflation by assessing how much it costs to rent a similar home. This is a concept known as owner's equivalent rent. (The idea is to measure the value of the “services'' provided by housing, separate from the investment return from owning a home.)
Rental and ownership measurements are typically linked because they are based on the same underlying data: surveys of thousands of rental homes. But the Department of Labor is giving more weight to housing that is comparable to owning a home when calculating ownership figures. This means that the two measures can diverge if different types of housing behave differently.
That may be what's happening now, some economists say. The recent boom in apartment building has led to lower rents in many cities. But while millions of millennials are reaching a stage where they want more space, single-family homes remain in short supply. As a result, home prices are rising for both buyers and renters. And since most homeowners live in single-family homes, single-family units play a very large role in calculating an owner's equivalent rent.
“More heat is behind single-family homes, and there's good evidence as to why it's going to continue to get hotter,” said Skyler Olsen, chief economist at Zillow.
A fluke or something more?
Other economists suspect January's rise in inflation is the start of a more permanent trend. Rent prices for single-family homes have been higher than rents for apartments for some time, but it's only recently that inflation rates for owners and renters have diverged. This suggests the January numbers were a fluke, argued Omer Sharif, founder of economic research firm Inflation Insights.
“Month-to-month things can be volatile in general,” Sharif said. He said the good news in the report was that rent growth was finally starting to slow down, reinforcing confidence that official data was showing signs of a long-overdue economic slowdown.
However, that conclusion is not certain. Before the pandemic, different parts of the housing market told a largely consistent story. For example, rents for apartments rose at about the same rate as rents for single-family homes.
But the pandemic has upset that balance, causing rents to rise in some places and fall in others, disrupting the relationship between different measures. That makes it less certain when and how much official data will cool, which could make the Fed more cautious as it considers rate cuts, said Sarah House, senior economist at Wells Fargo.
“At this point they still assume there's quite a bit of disinflation going on, but that should keep their optimism cautious,” he said, referring to Fed officials. said. “We have to think about where the shelter is actually located and how long it will take to get there.”