CAMS Weekly View from the Corner – Week ending 7/15/2022
July 18, 2022
This past week we citizens and market participants received a wealth of inflation information which continued to print multi-decade high growth rates.
Being price inflation is a top level concern for the citizenry we thought it timely to dig into the Consumer Price Index (CPI) a bit while simultaneously speaking to a topic we have written on in previous editions: Housing – or shelter as it is categorized within the CPI.
The CPI is published monthly by the Bureau of Labor Statistics (BLS). Within this report is a plethora of consumer items which collectively is meant to act as a broad consumer basket. Shelter constitutes a large percentage of the report which makes sense experientially speaking being shelter costs tend to be a notable percentage of most consumers monthly consumer basket.
CPI shelter costs represent a third of the basket (32.94% to be precise per the BLS) but actual home prices are not included. What?
Yes, home prices are not addressed but rather two forms of rent make up the shelter cost aspect of the consumer basket.
One is called Rent of Primary Residence which is 7% of the basket while the second is Owners’ Equivalent Rent (OER) which is 25% of the CPI basket. OER is computed via the Consumer Expenditure Survey not actual rent increases across the country.
If you find yourself to be part of said Survey you will be asked if you own your primary residence, if yes, then you are asked: “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”
What is your answer? (No you do not have time to do market research in order to come up with a current market rate and hence give an accurate answer.)
If you are like the vast majority of citizens you probably have no idea being you have nothing to do with the rental market nor have even contemplated renting your home being you need your home to live in yourself. Nonetheless, for the moment, you are viewed as a rental market expert and instant landlord.
What’s at Stake?
Consumer price baskets are meant to inform policymakers, business people, market participants, households, and bond/stock markets to name a few of what is taking place in the pricing environment within the nation.
If prices are not accurately accounted for then all the above entities and others within society are not properly informed and hence make forward decisions based on inaccurate data. This invites crucial policy errors that lead to downstream issues.
Think the Federal Reserve setting interest rate policy based on believing inflation is contained or to the degree there is inflation that it is “transitory” in nature – sound familiar?
Think at the household as it seems likely for the vast majority of citizens when considering housing costs they think actual home prices via current market levels (while paying for them over a period of time via a loan agreement) not an arbitrary rental rate established from a happenstance survey.
Click For Larger View: https://fred.stlouisfed.org/graph/?g=RP71
The above begins in year 2000 taken to current day. The red line represents the well known S&P/Case Shiller National Home Price Index while the blue line represents the BLS Owners’ Equivalent Rent. Both reflect the year-over-year price increase growth rate with our red horizontal lines highlighting notable timeframes in differentials between the two over the last twenty-plus years.
Our current era’s differential over the previous year-plus exceeds the other noted time periods including the well remembered housing bubble era in the front part of the 2000’s.
Federal Reserve officials were well quoted back then offering inflation was contained and hence no need for extraordinary policy moves to address the rapid housing price increases as a means to curtail the obvious and rampant speculation taking place nationally.
To add some detail to our generality the Fed began to raise interest rates mid-summer of 2004 after home prices had been posting high single digit escalating to double digit price increases for a few years previous. While actual home prices were escalating double digits the CPI’s Owners’ Equivalent Rent was actually declining in trend and posting a miniscule 2% growth rate for the bulk of the bubble years.
As bad as that was as a differential back then our current era of the previous year-plus exceeds it.
Taking the Above Back to Spring of 2021
Click For Larger View: https://fred.stlouisfed.org/graph/?g=RRA1
Above we bring CPI, OER and the stated Home Price Index all together. The red circle denotes how both the CPI and OER measures were contained albeit gently rising in the case of the CPI (red line) while the actual societal storyline for shelter costs, i.e. home prices were on a runaway uptrend via our red arrow.
Home prices were up 15% exceeding the peak of the aforementioned housing bubble years while OER was trending down and CPI was in the mid-2% level. In various editions back then we questioned the then budding “transitory” inflation phrase in part because of the above back in real time.
Importantly, with the above backdrop, CPI was in the low 2% area already exceeding the Federal Reserve’s multi-decade stated inflation ceiling of 2%.
Convinced of the transitory narrative they continued with their 0% interest rate policy and continued printing $120 billion of additional dollars every month $40 billion of which went into the Mortgage Backed Securities market only adding gasoline to a market that was already on fire trend wise per the chart above.
The above storylines have played a part in our now 9% inflation experience while the Federal Reserve is attempting to play serious catch-up with the largest one-time increases in interest rates in decades. This catch-up process, per numerous stock, commodity and bond market messages is walking the U.S. economy into recession.
The question is will the economy go into recession while the inflation levels remain elevated for some time to come? That is hallmark stagflation. Stagflation is an experience we also have not seen in decades but may indeed be coming our way down the near-term timeline.
I wish you well…
Director, Market Research & Portfolio Analysis
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