(Gemmer) The more you dig into how the inflation numbers are calculated the more perplexed you become. Take housing costs.
Home prices do not go into the inflation computation, only rental prices. The line of thinking is that buying a house is basically an investment rather than a consumption good. Which sorta makes sense, but then again, a lot of people have to pay something to live somewhere. A bit like food, which is considered a consumption good. Anyhow, rental prices make up a good bit of most inflation indexes. Shelter makes up 32.8% of the CPI index, and rent makes up almost 24%.
Obviously, home prices have been on a tear the last few months, with prices up roughly +17% over the last six months. Rental prices are up just 2%, as you can see below.
Another way to show this is through the price-to-rent ratio. It’s at its highest point in history. As a result, we have this weird disconnect between homes as an asset and shelter as an expense. As The Economist notes:
‘Over the long run, however, economic theory suggests that rents and prices should move in tandem (ie, the ratio of house prices to rents should be stable). If rental growth catches up with prices, that could have a big effect. Rents make up one-fifth of the basket used to calculate “core” personal-consumption-expenditure (pce) inflation, which excludes food and energy—the gauge most closely watched by the Fed. If annual rent inflation rose to 4% a year—not far off where it was shortly before the pandemic—overall core inflation would rise by 0.5 percentage points.’
Why does this matter? Because the Fed would probably look at this type of move as permanent inflation, not transitory, and tighten policy accordingly. But there are also structural reasons that could keep home prices elevated relative to rents (low interest rates, a slow pace of new home construction, development restrictions, etc.). Time will tell how this play out, but if it feels like there is a disconnect between the cost of living and the inflation data, there is!!
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