April 29, 2024

Housing represents an outsized piece of the complex inflation puzzle

Despite some whispers of caution, there have been many signs of progress in the broader inflation landscape in the past 12 months..

The Federal Reserve’s decision to elevate its baseline interest rates has led to a moderation in prices across various sectors. Supply chain disruptions have eased, leading to stabilized prices for groceries and other consumer goods.

Despite increasing slightly in the first quarter of 2024, the U.S. inflation rate stands at 3.5%, far below its 2022 highs. Many politicians, citizens, and investors believe it is time for the Fed to begin interest rate cuts in response to these positive developments.

Fed policymakers remain resolute they need to see more evidence of a sustainable inflation rate approaching 2% - but critics say the government’s method for estimating home prices makes that nearly impossible. While inflation has cooled in many other areas of the economy, housing prices continue to be stubbornly high, defying expectations.

Many say the problem is ingrained in the calculations used to determine housing values. The statistics for home prices come from the Consumer Price Index, compiled by the Bureau of Labor and Statistics. While gauging prices for goods and services is relatively straightforward, BLS methodologies for rentals and housing do not capture immediate fluctuations, and potentially distort inflation. Housing accounts for more than a third of total inflation.

The BLS collects data for about 40,000 residences through personal visits or telephone calls. To track changes, the data is divided into six panels, each of which is sampled every six months on a staggered basis.

To measure home prices, the BLS uses a value called “owners’ equivalent rent” (OER), an estimate of the price the home could be rented for monthly, not its actual asset value.

Additionally, the CPI tracks rents for all tenants, including those with existing leases, which may not reflect changes in the market for new leases accurately.

House prices and rental prices are determined by supply and demand factors that don’t always move in tandem. Over time, changes in house prices do predict changes in rents - although the relationship is far from one-to-one, and there is a time lag.

Imbalance between supply and demand contributes to competition among buyers, driving up prices and making it difficult for aspiring homeowners to find suitable properties.

However, there is reason for cautious optimism. A recent uptick in new listings suggests more sellers may be willing to enter the market, potentially easing some of the inventory pressure.

Forecasts are calling for a modest decline in mortgage rates in 2024, accompanied by steadier home prices. Rising new-home sales will continue to offer some relief to the market. But new construction alone cannot bridge the housing supply gap.

Surprising to some, data shows rents have been decreasing steadily the past six months. Nationwide, there has been a decline of 1% in the past year. Major cities like Austin, Atlanta, and Nashville have witnessed even more significant drops.

Housing’s significant influence on overall inflation readings poses a formidable challenge for the Fed’s inflation-fighting efforts and underscores the importance of addressing housing market dynamics.

As new construction projects continue to come online, mortgage rates stabilize, and the market evolves, the hope is housing inflation will subside, contributing to a more stable outlook in the long run.