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The January CPI overshot expectations by 0.1% and the stock market had convulsions. It’s absurd.
If it weren’t for shelter costs, which now comprise 25% of the CPI, the year-over-year change in the CPI would have been 1.6%, well below the Fed’s target and very good news for everyone.
But the way the BLS calculates shelter costs has boosted the reported year-over-year change in the CPI to 3.1%. Over the next 9 months, it is highly likely that shelter costs will fall by more than half, thus subtracting significantly from reported CPI. Meanwhile, the ex-shelter version of the CPI has been very well-behaved.
This is all a statistical tempest in a teapot.
Chart #1
Chart #1 shows the reported change in the CPI (blue line, 3.1%) and what it would have been ex shelter costs (red line, 1.6%).
Chart #2
Chart #2 shows us that the Fed’s method for calculating shelter costs today (the majority of which comes from Owner’s Equivalent Rent) has a very high correlation with the change in housing prices 18 months ago.
Absent any change in this methodology, we can predict that the change in OER will fall from the current 6.2% to 2.8% over the next 9 months.
Thus, future declines in OER, which are virtually baked in the cake, will subtract over half of the difference between the headline CPI and the ex-shelter CPI between now and September ’24.
Chart #3
Chart #3 shows the level of the Consumer Price Index ex-shelter costs. Note the rapid growth from mid-2020 to mid-2022, when the index rose over 23% (which translates into an annualized rise in prices of over 23%).
Now note how the growth of the CPI ex-shelter slowed dramatically beginning in mid-2022.
Since June 2022, the Consumer Price Index has increased at a benign rate of 1.2% per annum, and as noted above, it has increased 1.6% in the past 12 months with no signs of any acceleration.
Once again, it is safe to conclude that shelter costs and the way they are calculated have clearly overstated inflation.
The Fed will figure this out sooner or later. Meanwhile, short-term interest rates will be higher than they need to be, but not forever.
Monetary policy is “restrictive” only in the sense that borrowing is more expensive than it needs to be.
But because bank reserves are super-abundant (see Chart #2 in my last post), liquidity is abundant and the economy can continue to grow as it has in the past year or so – despite higher-than-necessary interest rates.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
