Pre-shelter inflation rose at a 1.0% annual rate since last June;  core inflation with real house prices at just 3.0% annualized

– by a New Deal Democrat

Two months ago I “officially” took the position that inflation was under control and that, properly measured, the economy had indeed been experiencing deflation since last June. With the revisions, “actual deflation” is no longer the case; but for the second month in a row since then, this morning’s CPI report shows that inflation is considered elevated at all only because of the lagged and fictitious nature of the house price measure.

The main reason I’ve been mulling over for almost 18 months is that the shelter component of official inflation, which is 1/3 of the total and 40% of the “core” measure, is lagging real data by a lot – as in, by a year or more .

Before we get into all that, let’s look at the headlines with monthly and yearly rates of change:

Headline CPI rose 0.4% month-on-month and 5.0% year-on-year (lowest since May 2021)

Core CPI rose 0.4% month-on-month and 5.6% year-on-year (lowest since January 2022)

CPI less shelter up +0.3% and 3.4% y/y (lowest since March 2021)

Core CPI less than shelter rose +0.4% and 3.8% year-on-year

Energy is up 0.6% month-on-month and down -4.9% year-on-year

Foods unchanged month-on-month and up 7.6% year-on-year (lowest since January 2022)

New cars fell -0.2% month-on-month and 5.4% year-on-year (lowest since June 2021)

Owner equivalent rent up 0.5% month-on-month and 8.1% year-on-year (all-time high year-on-year)

Notice the pattern with the above? “Lowest of…” for almost everything *except* shelter, which is at an all-time annual high.

Simply put, at this point both core and headline inflation are driven almost exclusively by owner-equivalent rent (shelter), with secondary help from food and new cars – and even those two are slowing down considerably. It is only because shelter is such a large component of the total that inflation is a problem. Even including new cars and food leaves annualized consumer inflation, which should be within the Fed’s comfort zone. Only core inflation at the ex-shelter remains somewhat elevated, at 3.8% year-on-year.

Let’s start with the year-over-year changes in headline inflation (blue), core inflation (red) and ex-shelter inflation (gold):

All three have been trending down since last June (header and ex-shelter) or last September (core).

Next, because of the importance of the shelter to my analysis, here’s an updated year-over-year long-term chart of the big culprit, owner-equivalent rent (son), which increased another 0.5% in April, with the FHFA home price index ( red, / 2.5 for scale), which is down since last June and is up 4.0% since its last February reading:

Just as I said over the last 18 months, house prices have dragged the OER up, and with it the CPI, with about a 12 month lag. Year-over-year home prices stabilized for a year between late spring 2021 and mid-2022, and now it looks like OER has finally stabilized as well.

Here’s what the former shelter would look like with core inflation:

This measure is significant, as it has stalled at roughly 4.0% on an annualized basis over the past few months. But that’s only partly because we really need to include the true measure of housing inflation — house prices — in the calculation.

As noted above, the FHFA Index was up just 4.0% year over year as of February. If it has continued to decline in the 2 months since then at the same rate, it is currently only up about 1.7% y/y vs. 8.1% for OER. If the FHFA index were replaced by the OER, then the April annualized total CPI would be only 2.8%. Core inflation, where the former shelter rose by 3.5%, will rise by just 3.0%. None of these warrants a restrictive interest rate policy.

Also, because of the importance of gasoline prices, which peaked last June at over $5/gallon, to core inflation, if we measure from last June, then core inflation ex-shelter increased only 0.8%, or at 1 .0% annual rate:

Which means, as I said above, food prices and new cars are also worth looking at.

Here are food prices both m/m (blue, left scale) and yearly (red, right scale):

Food price inflation slowed quickly. In the last 6 months, inflation has been 2.0%, or 4.0% on an annual basis.

Meanwhile, while used car prices rose 4.4% for the month, year-on-year inflation for both new cars (red) is also decelerating, albeit slowly, now at 5.4%, while used car prices at annual basis (blue) actually turned into deflation:

But to repeat: properly measured inflation is no longer an important issue. Inflation only increases because of the dummy and lagged measure of owner-equivalent rent. If actual house prices are used, even core inflation would rise by only about 3.0%. Even if the OER is a valid way to measure inflation, because of the severe lag the Fed has to rely on house prices and declare victory. No, but you should.

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