- Housing’s Pull: Inflation in Owners Equivalent Rent/Shelter have almost single handedly buttressed headline inflation growth over the last year.
- What if Housing Rolls? The Fed faces a Sisyphean inflation battle if the slowdown in housing drives deceleration in Shelter price growth
- Inflation Percolation: Food & Energy Costs are taking a rising share of consumer wallet, but moderate inflationary pressures continue to hold in the largest part of the economy
- Vicious Policy-Price Cycle: A material, policy driven acceleration in food and energy inflation only serves to slow inflation adjusted growth – particularly in a world of sub-trend credit and nominal wage growth.
- Fed Front Running: Investor positioning into slowing growth and the expected, reactionary policy response has become largely Pavlovian & the dollar continues to breakdown and commodities breakout.
“If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”
In you're unaware, that perfectly imprecise line of questioning, asked as part of BLS’s monthly price survey process, drives the calculation of “owner’s equivalent rent” and singularly represents approximately one quarter of the index used to calculate CPI inflation in the United States.
Calling out the sweeping subjectivity inherent in the domestic survey methodology is trivial at this point, but I still find it rather remarkable and worthy of a re-highlight every once in a while.
What hasn’t been trivial is the impact of owner’s equivalent rent on the reported inflation figures.
HOUSING’S PULL: CAN THE FED SUCCEED IF HOUSING FAILS?
Owner’s equivalent rent (OER) carries a 23.9% weighting in the CPI index as of the latest reading while Shelter more broadly, which also includes insurance and housing fuels and utilities, carries a 32% weighting.
What’s notable is that over the last year, the ongoing acceleration in OER and Shelter inflation has almost singularly buttressed headline inflation growth.
The chart below shows YoY growth in CPI Shelter vs. CPI All Items ex-Shelter. As can be seen, the divergence between the two measures has shown ongoing expansion over the last 3 quarters – a trend which extended itself in February with CPI Shelter flat sequentially at +2.6% YoY while YoY growth in CPI Ex-Shelter decelerated 60bps sequentially to just +0.5% YoY, its second lowest print since the end of the recession.
WHAT IF HOUSING REALLY ROLLS OVER?
Shelter and OER inflation is generally pretty sticky but 100bp moves in the rate of change of growth over a 12 month period aren’t abnormal. Housing activity has already begun to slow and home prices generally follow the slope of demand on a 12 to 18 month lag.
While the relationship between growth in shelter inflation and growth in home prices isn’t overly tight (and we need to do more work on this), it’s probably more reasonable to expect a material slowdown in home price appreciation to drag on shelter inflation than not.
In the chart/scenario analysis below, we show the trajectory for headline CPI growth over the next 10 months under a scenario of decelerating Shelter CPI growth.
Specifically, we’ve assumed CPI All-items ex-Shelter continues to grow at its TTM average of +0.9% over the balance of 2014 while CPI Shelter decelerates 100bps ratably, from +2.6% to +1.6%, over that same period.
Obviously, any number of scenario iterations can be envisaged, but under a scenario of modest deceleration in Shelter inflation, headline CPI growth would struggle to stay north of 1% over the remainder of 2014.
Food & Energy costs have been the notable positive diverger, taking a greater share of consumer wallet YTD as protein and fuel cost have tracked back towards peak 2011 growth levels.
However, pockets of inflation have been percolation eslewhere as well despite the broader disinflationary trend.
CPI Services growth continues to hold above 2% and the growth trend looks similar even if you strip out the Shelter and Energy components of the Index. On a YoY basis the slope of Services price growth is slowing, but it continues to accelerate on a 2Y basis.
We’d argue that the 2Y comps generally offer a cleaner read on the Trend rate of improvement as outlier impacts and odd comp dynamics get smoothed, but the read through is somewhat equivocal here.
The general takeaway is that the headline inflation figures modestly belie more moderate inflationary pressures in the largest part of the economy.
PERVERSE POLICY-PRICE CYCLE....AGAIN
With the Fed rhetorically abandoning their 6.5% unemployment target, we’ve received the first tangible confirmation of what everyone already intuitively knew – namely, that data dependence and forward guidance can’t credibly co-exist.
With the fed broadening its “qualitative” focus across a broader swath of labor market data, talk of an inflation floor or other more inflation specific guidance is also likely to emerge as the Yellen transition matures.
If rent inflation decelerates alongside the slowdown in housing, it will become increasingly harder for the Fed to achieve its stated inflation target. To the extent they implement incremental easing to help combat another round of disinflation, it’s likely to perpetuate further speculative investment in hard commodities and other currency debasement and inflation hedge assets.
Unfortunately, a material, policy driven acceleration in food and energy inflation only serves to slow inflation adjusted growth – particularly in a world of sub-trend credit and nominal wage growth.
#InflationAccelerating: Base effects alongside the combination of investors/$USD front-running a rhetorical shift in policy as the slope of domestic growth slows anchored our 1H14 #InflationAccelerating call.
Investor positioning into slowing growth and the expected, reactionary policy response has become largely Pavlovian.
With the dollar in bearish formation (Broken TRADE/TREND/TAIL) and back near 52-week lows, slow-growth equities leading (Utilities outperforming consumer by >900bps), and Gold and the CRB Index outperforming almost every other asset class YTD at +13% and +8%, respectively, investors again appear to be (attempting) to front run the Fed.
Christian B. Drake