This Week’s Developments in the US Economy

How Rent and Home Price Metrics Drive This Week’s CPI Surprise

Moving markets this week, the January CPI reading came in higher than consensus expectations. A primary driver is the combination of rent and home price metrics, which we have described for several quarters as “sticky” and likely to keep inflation readings artificially high. This has meaningful implications for Fed policy insofar as their stated objective is to see a sustained path toward 2% inflation. As we look at the final pieces of the inflation puzzle, it becomes apparent that the shelter component might be the last domino to fall. Energy inflation has seen deflationary conditions for several months, and commodities dropped down into negative territory for the first time in over three years at -0.3% year-over-year.

We anticipate a significant decline in the shelter component over the next six months for the reasons described below, potentially even entering negative territory—at least in the for-rent measure should current trends continue. If this holds true, we anticipate that the Fed will see the sustained readings it expects, which supports our expectation for the first rate cut towards the middle of 2024.

Inflation Sees a Continued Downward Trajectory
In January, headline CPI reached 3.1%, while core CPI stood at 3.9%. Notably, the shelter index, comprised of a combination of multifamily rent data and an approximation of rents for single-family homes owned by their occupants, makes up 36% of headline CPI. Of the 6.0% rent of shelter inflation component posted in January, approximately one-quarter is attributed to the rent of primary residence and the other three-quarters are attributed to owners' equivalent rent of residences.

We expect the upcoming reading for PCE, the Fed’s preferred inflation gauge, to show less influence to housing costs as the shelter component constitutes a lower share of headline PCE at approximately 15%. In December, PCE recorded headline, core, and shelter inflation figures of 2.6%, 2.9%, and 6.4%, respectively. Despite progress in overall CPI inflation since peaking at 9.1% mid-2022, the persistent lagged nature of the shelter component remains an obstacle in lowering inflation to the Fed's stated 2% target.

What Is Happening to Rents?
Using Apartment List’s National Rent Report reveals six consecutive months of negative month-over-month rent growth across all tracked metro areas and national levels, a general trend not uncommon from a seasonality perspective but meaningfully higher in comparison to historical patterns. This is underscored by negative year-over-year rent growth nationally since June 2023, which is primarily ascribed to a strong pipeline of multifamily deliveries. Considering the lagged effect of shelter on inflation, the leases signed at lower rent levels during the second half of 2023 will likely start impacting inflation figures in the near term.

While rent growth may show slight improvements as seasonality effects dissipate, we expect higher multifamily deliveries will weigh on rent growth throughout 2024. However, we anticipate that this will be short-lived as starts and permits for multifamily properties peaked in 2022, and the Census Bureau's 2022 construction survey indicates an average multifamily permit-to-completion time of approximately 20 months. This points to many 2022 starts reaching completion in 2024 and exerting continued downward pressure on rents, consequently impacting inflation—albeit measured on a lagged basis.

What Is Keeping Home Prices Elevated?
Even as rents come down, we are seeing home prices still going up. According to the National Association of Realtors (“NAR”), the median existing single family home price has surged by 54% since the beginning of 2019. Further, over 85% of metros posted an increase in single-family existing home prices in Q4 2023, according to the NAR, and the national median home price rose by 3.5% year-over-year. Prices are maintaining elevated levels as elevated mortgage rates impact the supply of existing homes entering the market. December 2023 saw 3.8 million existing home sales at a seasonally adjusted annual rate, notably below the 2010-2019 average of 5 million. Although home prices aren’t directly factored into inflation figures, their rise exerts upward pressure on demand for rentals and subsequently on rents, albeit with a substantive lag of 18 months, according to research by the Dallas Branch of the Fed. While overall inflation is expected to decline as shelter inflation follows decreasing rent growth, it is noteworthy that sustained high home prices could contribute to the persistence of shelter inflation in the long run.