On Thursday morning, the U.S. Bureau of Labor and Statistics (BLS) released the newest inflation data from July, and it begged the question, is the shelter component sticky or just slow? It may become a fundamental question as the Fed weighs its options on future rate increases, so let’s take a look.
Before looking at the shelter component, it’s important to note that both headline and core CPI have slowed dramatically toward target over the last six months, down to 3.2% and 4.7%, respectively. Even so, rents, as reported by CPI, are still very high. Shelter inflation (which includes actual measured rents, owners’ equivalent rents that estimate the amount an owner would pay to rent their home given market rents and hotels) was up 5.4% annualized in July and 7.7% YoY. That is the slowest pace since last year but still more than twice as fast as would be consistent with the moderate inflation environment of the 2010s. The current rent inflation numbers are still hot enough to generate almost 80% of the total headline YoY inflation.
The good news is that leading indicators suggest a long runway for cooling rents. The CPI estimate for rent uses a complicated procedure that tends to lag actual contract rents because most renters only see their costs change when they sign or renew a lease. Therefore estimates of rental expenses in CPI are, by design, quite lagged, which trades a more representative sample of actual consumer experience for a delayed snapshot of rental markets. CPI rent eventually tends to follow more “real-time” estimates of median rents—for instance, those published by Zillow. As shown below, Zillow-signed rent changes tend to lead actual CPI for rent by about a year and suggest that further declines in rental inflation are barreling down the pipe.
Moreover, there are other reasons to expect rents to slow further. For instance, Apartment List’s estimate of national vacancy rates continues to rise and is well above levels from before the pandemic. The Census publishes a lower-frequency and more comprehensive snapshot each quarter, which shows a lower and slower-rising vacancy rate. Either way, the most extreme vacancy rates recorded during the pandemic are now in the rearview mirror.
Lastly, more supply of rental units is likely to be a further catalyst for weak rents relative to what the BLS is currently reporting. Currently, a backlog of multifamily housing units (primarily apartments or for-rent units) is at a record high of 994K. In addition, multifamily completions are among the highest readings of the past three decades. This means that a lot of supply is close to hitting the national rental market amidst slowing rents and rising vacancies, which is likely to lead to further deceleration in rent growth, if not outright declines.
All this to say, based on higher frequency and forward-looking data, the single most significant contributor to inflation should be cooling in the coming months. And as to whether shelter is sticky or slow, hopefully, it is clear that shelter is a lagging indicator, which means while it appears sticky, it is really just slow.
Economy
- U.S. equity markets continued to slide this week, with the S&P 500 down -0.3%, the Nasdaq down -1.9%, and the small-cap Russell 2000 down -1.7%. Markets tried to recover on Thursday after encouraging inflation news; however, it wasn’t to be.
- U.S. Core consumer prices, which exclude volatile items such as food and energy, rose by 0.2% MoM in July, matching June’s advance, in line with market forecasts.
- The annual inflation rate in the U.S. accelerated to 3.2% in July from 3.0% in June but below forecasts of 3.3%. It marks a halt in the 12 consecutive months of declines due to base effects.
- The number of Americans filing for unemployment benefits jumped by 21K from the prior week to 248K for the week ending August 5th. This was the highest in one month and sharply above expectations of 230K. Despite remaining at a historically low level, the figure suggested that the U.S. labor market is starting to soften from stubbornly tight levels since the start of the year.
- Producer prices in the U.S. rose 0.3% MoM in July, the biggest increase since January, and above market forecasts of 0.2%. It follows a downwardly revised flat reading in June. Services prices were up 0.5%, the most significant rise since August 2022.
Stocks
- U.S. equities were in negative territory. Technology and Consumer Discretionary led the decline, while Energy and Healthcare outperformed. Value stocks led growth stocks, and large caps beat small caps.
- International equities closed lower for the week. Developed markets fared better than emerging markets.
Bonds
- The 10-year Treasury bond yield increased 11 basis points to 4.17% during the week.
- Global bond markets were in negative territory this week.
- High-yield bonds led for the week, followed by government bonds and corporate bonds.
