Update 780 — April CPI Report a Relief
Though Rent Remains “Too Damn High”
This morning’s Consumer Price Index report for April confirmed an expected relief regarding inflation, with core CPI — overall prices excluding food and energy — up just 0.3 percent since the March report and a 3.6 percent increase in prices from a year ago, the lowest such annual figure since April 2021. The good news rekindled speculation of a Fed interest rate cut as early as September.
The most concerning and stubborn component of the price picture, once again, was shelter costs, up 0.4 percent over the month and 5.5 percent from a year ago. Today, we drill down on this component, a lagging indicator, which suggests the end of the tunnel is not quite yet at hand, and the implications for the elections in the fall.
Best,
Dana
Rate of CPI Increase Ticks Down in April
This morning, the U.S. Bureau of Labor Statistics released its latest Consumer Price Index data, which showed that headline inflation rose by 0.3 percent from March to April, slightly down from the monthly increases of 0.4 percent over each of the prior two months. Headline CPI, measuring the rise of all prices throughout the economy, showed prices rising at an annual rate of 3.4 percent, down slightly from the 3.5 percent seen in March.
Core CPI, which excludes food and energy prices, rose by 0.3 percent over the month after rising by 0.4 percent in each of the prior three months. Over the prior twelve months, core CPI rose by 3.6 percent, falling to its lowest annualized level since 2021.
Source: Council of Economic Advisers
The price of shelter (primarily rental housing and owner-occupied housing) and gasoline contributed over seventy percent to April’s overall increase in headline CPI. The Fed has been paying particular attention to housing costs – or shelter costs, as it is referred to when discussing inflation – which play an outsized role in how inflation is measured. The shelter index rose by 0.4 percent in April and by 5.5 percent over the prior twelve months.
The shelter index was the largest factor in the monthly increase in core CPI. Prices of both rent and owners’ equivalent rent (OER) – calculated by estimating the monthly rent that homeowners would theoretically pay if they paid monthly rent on their homes – rose by 0.4 percent over the month.
The energy prices increased by 1.1 percent overall last month, with gasoline prices rising by 2.8 percent in April. Food prices were unchanged in April. Prices of motor vehicle insurance, medical care, apparel, and personal care also rose last month, while prices of cars and trucks, household furnishings and operations, and new vehicles fell.
Today’s report is surely a welcome sign for the Federal Reserve, which has been looking for signs of deceleration in inflation before it begins to cut interest rates from their current level of 5.25 to 5.5 percent. The Fed had hoped that CPI data showing higher inflation in January and February were inflated because of seasonality. March’s higher-than-expected inflation data suggested that inflation may be sticky, potentially pushing the Fed to hold rates at an elevated level over a longer period. This morning’s soft CPI data provides an early sign that inflation may be returning to its previous trend, in which it gradually falls towards the Fed’s target of two percent.
Housing Costs Keeping Inflation High
Shelter costs have been a major contributor to overall CPI over the past twelve months. These costs constitute one-third of the CPI and one-sixth of personal consumption expenditures. As such, to get inflation under control, the rise in shelter costs would have to begin cooling as well.
The Fed expected shelter costs to slow down when it first began raising rates in 2022. To the Fed’s credit, housing inflation has slowed from its peak at 8.2 percent over a year ago; but as of last month, housing inflation was still at 5.5 percent, considerably higher than anyone had hoped for. Market prices of shelter costs have been rising at a slower pace, as reflected in market data, but part of the reason that the CPI’s shelter index remains so high is that it is a lagging indicator.
Trend in Shelter Prices vs. Headline CPI, Core CPI, and Headline CPI Less Shelter Prices (Apr 2019 – Apr 2024)
Source: Federal Reserve Bank of St. Louis
Housing costs are measured by looking at market rents, meaning rents on newly-signed leases, while housing prices for homeowners, as mentioned above, are calculated by estimating the monthly rent that homeowners would theoretically pay if they paid monthly rent on their homes. Since only a fraction of leases turn over in a given year, that creates a lag in measuring housing inflation when compared to current trends in market rents. Changes in housing prices can take at least 15 to 18 months to be reflected in inflation measures. Today’s report suggests that housing inflation still has a way to go before it is under control.
While many took this lag into consideration when predicting a cooling down of inflation in 2024, the realities of the housing market have complicated the Fed’s mission to bring down housing inflation. Most notably, America’s housing shortage has fueled increases in housing costs as demand chases a limited supply. America faces a shortfall of between 1.5 million and 5.5 million units, driving the price of a new home up from $357,000 in 2021 to $485,000 this year.
Higher home prices combined with higher mortgage rates have pushed would-be buyers to continue renting instead and interest rates held high by the Fed slow new home construction and home renovation. When combined with the fact that the inventory of rental units is historically low as well, this has resulted in market rents remaining stubbornly high. While year-over-year rent growth has slowed to 3.4 percent as of February as new apartment supply became available and the income growth of renters slowed, it still has much cooling to do if overall housing inflation is to be brought down to the Fed’s target levels.
All of this begs the question as to when we can expect to see lower housing inflation become visible in overall inflation data. Many economists are still holding out hope that CPI showing a slowdown in housing inflation, reflecting changes in the housing market, is imminent. Others expect it to take longer as more renters delay becoming homeowners and renew their leases instead. The numbers reflected in the April CPI report suggest that there is still a long way to go before housing inflation is brought under control.
Political Implications
Inflation trends over recent months come as candidates from both parties attempt to make their case and voters make up their minds for the 2024 elections. Republicans continue hammering the issue of inflation on the campaign trail, especially against President Biden who has been largely focused on highlighting cost-cutting among his administration’s significant and broad economic achievements.
Inflation has been a vexing problem for the current President as voters have focused on price increases rather than other indicators such as real growth and employment conditions, which would be more flattering for Biden. A recent poll conducted by The Economist/YouGov found twenty-two percent of voters identify inflation and prices as their most important issue, compared to seven percent who rank jobs and the economy the highest. Voters may be keenly feeling the impact of inflation, particularly the pressure of housing costs, as rent has been rising faster than wages across the country, particularly in several major cities.
Reflecting the challenge for Democrats, the May update of the University of Michigan Consumer Sentiment Index released last Friday showed a general decline in consumers’ short- and long-term expectations for the economy to a sixth-month low. Expectations for inflation rose from 3.2 to 3.5 percent in the short-term (one year) and from 3.0 to 3.1 percent in the longer-term (five years) as compared to last month’s data, signaling the absence of immediate relief for Democrats worried about how concerns about prices may affect their odds in November.
A cut in interest rates facilitated by a decline in inflation could help shift the way voters are thinking about the economy. If inflation returns to the path it was on in the latter half of 2023 – moving down to the Fed’s two percent target – the Fed may get the evidence it needs to finally begin cutting rates. Such a trend would almost immediately bring borrowing costs down throughout the economy. Consumers who have faced high interest rates since the Fed began its campaign to lower inflation in 2022 would get some relief months before they head to the polls. Even if this happens, consumer sentiment suggests that the economy may continue to be a losing issue for Democrats in the months ahead. If inflation stabilizes at present levels, Democrats hoping for a mid- to late-2024 rate cut may not see such a move until after the election.
The path of inflation and interest rates remains uncertain as we approach November. As the Fed weighs cutting rates, its policy moves will shape competing economic narratives for both parties and voters’ perceptions ahead of the 2024 elections. Of all the economic variables at play, the trajectory of interest rates is a pre-eminent factor guiding whether the economy is seen as a tailwind or headwind for candidates President Biden and Donald Trump.