Gimme Shelter
Ooh, a storm is threatening
My very life today
If I don't get some shelter
Ooh yeah, I'm gonna fade away
Rolling Stones – “Gimme Shelter”
The Consumer Price Index for All Urban Consumers (CPI-U) for
April showed a 0.3% increase in April after rising 0.4% in March. That puts
inflation at 3.4% year-over-year (y-y), which ticked down by 0.1% from March’s
reading, but still above the Fed’s target of 2%.
While many of the expenditure categories are in line, there
is one pesky category that will continue to be a thorn in the side of the Fed
for a while based on current policy.
So Inflation Went Down… That Is A Good Trend, Right?
Of course, the downward trend is good, but consider that in
June of 2023, inflation had plummeted to 3% y-y. Throughout the rest of the
year it bounced around before hitting 3.1% in January but has ticked back up
since. When you consider all items less food and energy there has been a pretty
steady decline over the last year, but that value is still higher (3.6% y-y).
Are We Going To Get to 2% This Year?
It doesn’t look too likely. Consensus puts inflation at the
end of the year in the 2.6% to 3.0% range. If you look at the Personal Consumption
Expenditures Price Index (PCE), the Fed’s preferred measure of inflation, that
window sits a little lower at 2.0% to 2.4%.
Fed Chair Jerome Powell even quipped about inflation during
a panel discussion at the Foreign Bankers’ Association in Amsterdam recently, “We
did not expect this to be a smooth road, but these were higher than I thank
anybody expected. What that has told us is that we will need to be patient and
let restrictive policy do its work.”
While we appear to be short of the mark, the good news is
that two-thirds of economists still think the Fed will cut rates by September
if they feel “things are moving in the right direction.”
What Is Keeping Inflation So High?
When looking at the expenditure categories on a year-over-year
basis, the major category changes (>6% of the value and percent weighting
used):
- Food +2.2% (13.4% importance)
- Energy +2.6% (6.9%)
- Commodities -1.3% (18.7%)
- Shelter +5.5% (36.2%)
- Medical Care +2.7% (6.5%)
- Transportation +11.2% (6.5%)
Motor Vehicle insurance is up 22.6% y-y (which counts for
2.9% of the overall inflation calculation). This makes sense as the insurance lagged
as drivers started opting for higher-end cars post-pandemic.
Shelter Seems A Bit High?
Herein lies a big issue with getting inflation under
control.
Almost 5 million new housing units have been added nationwide since 2020, mostly single-family homes. About half of this increase occurred in Texas, Florida, California, North Carolina, Georgia, and Tennessee which mirrors America’s post-pandemic moving patterns.
Despite the building boom of houses and multifamily
properties in the last few years, we still have a housing shortage. Moody’s
estimates that there is still a shortfall of 1.2 million single-family homes
and 800,000 rental units. The National Association of Realtors pegs the deficit
at around 2.5 million units.
The Rent of Shelter component of the CPI-U accounts for
35.7% of the overall CPI (or most of the Shelter component) stands at +5.6%y-y.
Driven by the Fed’s interest rate hikes, mortgage rates remain elevated which has
priced many homebuyers out of the market. This push people back into the rental
sector, increasing demand for rentals, which drives up rental prices.
Developers are hesitant to add new stock to the rental
market with tightened lending standards and high rates, thus creating an
endless cycle that a rate cut by the Fed would provide some relief from.
Yes, but not right away.
A rate cut (or cuts) coupled with the 981,000 apartments
under construction at the end of last year that should be online by the end of
2024 will help to ease shelter costs and overall inflation. If anything, as
the interest rate decreases, developers will increase activity, mortgage rates will
lower, and renters will shift to become homebuyers.
Any relief in the Shelter category will lag by months from any action by the Fed and y-y numbers will struggle to get to a reasonable level by mid-2025. The cycle will start to break in the third quarter of this year after seeing a flat month-over-month increase at 0.4%.
Expect that it will continue to stay elevated in relation to other major expenditure categories used to compute inflation until it ticks down to a more reasonable 0.2% m-m pace by the fourth quarter of 2024.
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