– by a New Deal Democrat
Over the past year, consumer prices have been driven mainly by two things: (1) the huge rise and then fall in gas prices; and (2) the phantom threat of owner-equivalent rent pulling shelter prices up even as real housing prices have peaked and new rental prices have also fallen. That remained the case this month.
Last month I wrote that “I suspect that oil prices have bottomed out for a while and so the noble decline in gas prices that followed is coming to an end. . . In short, I do not expect the streak of excellent CPI reports to continue.”
That was certainly true in the morning report for January. Energy prices rose 2.0% for the month, the highest since June. Overall, prices rose 0.5% for the month, also the highest since June. But core inflation came in at +0.4%, still elevated but around the average of the past year.
However, as price increases in January were smaller than a year ago, year-on-year price growth continued to slow. At 6.3%, headline inflation (in blue below) was the lowest year-on-year since October 2021. At 5.5% and 6.2%, core inflation (red) and non-energy prices (gold) saw the most -the low year-over-year increase since December 2021. And energy Year-over-year (grey, right-hand scale) at 8.2% year-over-year was well below its peak of 42% last June:
At +0.5% for the month and 10.1% year-on-year, food inflation remains a concern, but even this gauge has slowed from its peak:
New car prices rose just 0.2% for the month and 5.8% year-on-year, while used car prices fell -1.9% for the month and -11.6% year-on-year. However, they have risen by 20.1% and 37.2% respectively since the start of the pandemic:
Finally, as I noted at the outset, the phantom threat of owner-equivalent rent continues to drag both headline and core inflation upward. OER increased by 0.7% for the month (slightly below its monthly peaks of 0.8%, but year-on-year OER rose to another new record high of 7.8% (blue in the chart below). This contrasts with annualized real home prices as measured by the FHFA, which have declined sharply since last summer’s peak of 20%, and are up 11% as of October (red):
If the FHFA index continues to decline in its next few reports on its latest trend, then its actual reading for January will only be around +5.3% y-o-y – as OER will likely continue to rise at least slightly.
Replace the OER phantom threat with actual house prices and headline inflation is likely to be about 0.8% lower, or about 5.5% year-on-year, and core inflation will be about 1.0% less , or 4.5%.
The bottom line is that the boon from lower gas prices is probably over, but inflation — at least if we’re to measure it by actual rather than fictitious prices — is slowing significantly (with the exception of food, which remains problematic) and may came close to the Fed’s target sometime in the spring.
First of all, CPI ex-shelter actually *decreased* -0.8% since last June:
This isn’t exactly unprecedented, but as the chart below showing the q/q% change in CPI ex-shelter shows, it didn’t happen at all between 1960 and the turn of the millennium and has happened a few times since the housing crash of 2006 at:
To really show you the impact of OER vs. actual housing prices on shelter, the chart below shows the year-over-year change in the non-sheltered CPI (blue), currently 5.7%, the shelter CPI (which uses the OER, red) and the FHFA monthly home price index through its latest reading (gold):
Again, if house prices are used in the CPI instead of the OER and continue to decline according to their recent trend, then inflation will be on track to be close to the Fed’s target sometime in the spring.
And even if there is justification for using the OER for inflation, given its 1 year+ lag on home prices, there is no reason the Fed shouldn’t use a measure of the home price-adjusted CPI to set interest rates.