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By Robert Dishner
When shelter turns, inflation could start to come down more rapidly.
U.S. consumer price inflation remained elevated in May, and while core CPI decelerated on a year-over-year basis from 6.2% to 6.0%, its composition suggests that the rate of decline could take further time to accelerate. As a result, we think the Federal Reserve is likely to remain hawkish both in policy and communication until there is a turn in either the labor data or an improvement in inflation.
Putting things in perspective, by this time next year core inflation could be back below 3%, driven by (1) the lagging impact of Fed policy, 2) a shift of spending from goods to services, 3) services declines after the summer reopening, 4) economic deceleration and 5) moderation in housing prices. The latter could take the longest to show improvement, but when it does it the shift could be more rapid.
In the latest print, shelter costs increased by 0.6% month-over-month, their highest rate since January 1991. The shelter category is over 40% of core CPI. Of the 114 months since February 1953 in which shelter inflation was greater than 0.6%, it was lower a year later in 82 of those cases, with an average decline of over 50%. Of the 32 remaining cases, 28 of the increases happened prior to 1980.
Housing activity is already decelerating and is at the leading edge of Fed policy.
- Weekly Purchase Mortgage Applications are at their lowest levels since 2015 outside of COVID and the 2016 election (as well as some one-off weeks that saw quick rebounds).
- Existing home sales are at February 2020 levels and 15% lower than pandemic highs.
- New home sales are 43% below pandemic highs.
- Pending home sales are at their lowest levels since 2014, and 21% below pandemic highs.
- Housing starts and building permits are still at elevated levels, but we expect those to turn soon.
As housing activity slows, pricing should normalize off of elevated levels. This may take time, particularly as the U.S. has underinvested in housing over the last decade. The Fed is not going to wait, and we believe it will to continue to try and reduce demand both for housing and other goods and services via higher rates. At the same time, we believe the Fed will try to avoid being a source of market volatility, but rather emphasize its data-dependent approach while seeking to ensure that its reaction function is well articulated.
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