How Good Was the CPI Report?

By Hightower Omaha on July 14, 2023

July 14, 2023

Just as the markets seemed to predict, this week’s inflation data for June came in better than expected. The CPI grew at a year-over-year rate of 3.0% for the month, which was down from 4.0% in May and was slightly below expectations. If we exclude the volatile categories of food and energy, the core CPI was up 4.8% – down from 5.3% in May and below the consensus expectation of 5.0%. Those figures do indeed sound encouraging relative to expectations and the results for May, but they are still well above the Federal Reserve’s target of 2.0%. Given that the Fed really doesn’t consider food and energy prices in its monetary policy decisions, it seems like 4.8% is still a considerable distance from that target of 2.0%. 

There were a couple of categories that contributed to the inflation moderation in June. In the chart below, I show the various categories of prices that go into the computation of core CPI. The categories are sorted by their relative weights, starting with the highest weights on the left and decreasing as you go to the right. You will notice that for three of the categories, Medicare Care Services, Used Cars and Trucks and Education and Communication Commodities, prices fell on a year-over-year basis. If I exclude those three categories from the calculation of core CPI, the adjusted year-over-year growth would have been closer to 6.2%. That doesn’t sound too good.

So, why such a positive reaction to the data? Well, it turns out that changes in the cost of shelter, which currently represents nearly 35% of total CPI and over 43% of core CPI, are being vastly overestimated right now. As I pointed out in my Market Commentary from May 12, the two big categories for shelter within the CPI are rent of primary residence and owner’s equivalent rent (OER). OER represents “how much money a property owner would have to pay in rent to be equivalent to their cost of ownership,” (Wikipedia). We learned yesterday that prices for these two shelter categories were up 8.3% and 7.8%, respectively, on a year-over-year basis in June. Those outsized increases contributed heavily to the 4.8% year-over-year growth in core CPI. In fact, if we exclude those costs, core CPI excluding shelter would have increased just 2.8% year-over-year. 

This is an important issue because the government data on shelter costs lags actual rent changes, and all evidence, both hard and anecdotal, suggests that growth in shelter costs is now coming way down from recent highs. The chart below, which was taken from the ApartmentList.com website, shows the disparity between the CPI data for rent costs and ApartmentList’s National Rent Index. While the index was up 0.4% in June compared to May, it was flat on a year-over-year basis compared to the 8.7% increase in CPI Rent of Primary Residence in May (which came in at a still-elevated 8.3% for June). The reason for the disparity is that the government’s data includes all leases, both new and existing, and the ApartmentList index only includes new leases. 

Here are some quotes from ApartmentList’s June 28 press release:

“This means that on average across the nation, apartments today are renting for the same price they did one year ago.”

“The supply side of the rental market also hit a major milestone this month: our vacancy index now stands at 7.2 percent, matching the peak vacancy rate that was measured at the height of the COVID-19 pandemic. With a record number of multi-family apartment units currently under construction, this vacancy rate will remain elevated for the first time since the early stages of the pandemic and put pressure on property owners to find tenants, rather than the other way around.” 

“The Apartment List National Rent Index has proven to be a strong leading indicator of the CPI housing and rent components, as it captures price changes in new leases, which eventually trickle down into price changes across all leases (what the CPI measures).”

“Now in 2023, our index shows that the rental market has been cooling rapidly for a year, but the CPI housing component has just recently hit its peak. Despite the CPI’s measure of housing inflation remaining elevated, topline inflation has already meaningfully cooled. As the CPI housing component now gradually begins to reflect the cooldown that we’ve long been reporting, it will help to further curb topline inflation in the months ahead.”

“June is peak moving season and typically brings some of the fastest month-over-month rent growth observed each calendar year. In pre-pandemic years, June rent growth averaged +0.9 percent. But in 2023, June rent growth came in at just +0.4 percent and is already trending down for the season. This stagnation indicates that the market cooldown that started in the second half of 2022 is continuing, even as prices rise modestly month-over-month.”

“The surging rent growth we observed in 2021 and early-2022 is now solidly behind us.”

Conclusion: “June’s 0.4 percent national rent increase (compared to May) represents a further deceleration of the rental market, indicating that the market remains sluggish throughout what should be the busy moving season. Year-over-year growth fell once again, this time reaching zero for the first time since early in the pandemic. Even if the end of this summer brings a resurgence in demand, a strong construction pipeline should temper rent growth for the remainder of the year.”

Obviously, the Fed knows all this, and that’s why there is now much less concern about housing costs among the Fed’s membership. As the growth in shelter costs continues to decline in the months ahead, the Fed now has a much more predictable path toward its inflation target. The last remaining concern at the Fed is the persistent strength in the labor market, and there are signs of some cracks there as well, including lower job openings, rising claims for unemployment, slower wage gains, lower hours worked and falling quit rates. 

Not all of the labor data is deteriorating, and so most economists believe the Fed will follow through on its expected rate hike at its next meeting. For my part, though, I continue to believe that the economy is headed for a meaningful slowdown as the lagged effect of 500 basis points in Fed rate hikes increasingly takes hold. As the weaker economy starts to negatively impact the corporate earnings outlook, stock-market gains will be much harder to come by.

Peace,

Michael