- by New Deal democrat
Starting tomorrow we get to the time of month when the data on the important long leading sector of housing begins to be reported. So let me update a few important points about where this sector is likely going and its effects on the economy.
As we probably all know by now, housing costs in the form of Owners’ Equivalent Rent and Rent of Primary Rresidence are about 1/3rd of the entire CPI, and about 40% of core inflation. Where are they going?
Let’s start with rents. The Philadelphia Fed has an experimental “New Tenant Rents Index” and “All Tenants Regressed Rents Index” that are culled from the same data that gives rise to the CPI numbers, and are designed to lead the Rents portion of that index.
They were recently reported for Q3, and while unfortunately they are not presented in graph form, Ben Casselman of The Economist has provided such an update:
The graph suggests that the CPI measure of rents lags the “All Tenants” index by 2 quarters on average. Past day, most notably from 2009-10 and 2020-21 suggests that CPI for rent will continue to decelerate to approximately the same level as the All Tenants index, unless the New Tenants index rises significantly in the meantime. In Q3 the All Tenants YoY% increase was 3.8%, and the New Tenants YoY increase was 1.0%. On average the CPI rents YoY% change in Q3 was 4.9%. *If* the New Tenants index remains somnolent, this suggests the YoY% change in CPI for rents should decline to under 4% YoY in the next 4-6 months. In the past 6 months, the CPI for rent has risen at a 4.4% rate, so some further deceleration must occur if this forecast is to come true.
Similarly, the continuing slow decline in the house price indexes (FHFA is shown below) suggests that the CPI for Owners Equivalent Rent should also continue to decelerate:
There’s no magic 1:1 monthly correspondence to the lag in CPI vs. house prices. Above I show both the quarterly (dark red through Q2) and monthly (light red through August) changes in the FHFA index. Over the last two quarters, the YoY increase in the FHFA index has averaged roughly 5.5%. This suggests that the OER is currently “aiming” for roughly a 2.2% YoY increase in the next 12-18 months, depending upon the course of house prices in the near future.
But if shelter inflation can be expected to continue to moderate, the news is not so good about new construction.
As I always say, mortgage rates lead new construction. Here’s the latest updated graph of rates (blue, left scale) vs. permits (red, right scale):
More or less mirror images, with a slight lag between rates and permits. TNiehter the summer decline in rates, nor the subsequent increase, have yet been reflected in permits. Generally this suggests that permits will stay in the same range as they are presently.
Let me elaborate on this a little bit, and make a long term statement as well.
On the left below is a snapshot of the Treasury yield curve, showing its steep inversion in summer just before the Fed made its first rate cut (light red), and its current generally flat status (dark red):
As with the graph of mortgage rates above, what is most interesting here is that longer rates beginning at about the 7 year maturity have risen even as the Fed has cut rates twice. This suggests that the bond market, at the moment, thinks this will lead to a little more inflation. If mortgage rates do not meaningfully decline in the near future, the housing market is going to remain moribund.
And here is where the longer term secular issue comes in. It seems very likely that the next Administration is likely to want to pursue a high-deficit, easy money policy. If so, it almost certainly will ultimately get its wish with both the Congress and the Fed (after new appointments and possibly firings as well).
Such a policy is going to be inflationary, and is likely going to mean that long term interest rates like for mortgages will not return anywhere close to their post-pandemic lows.
Interest rates move in very long cycles. There was a declining rate long-term secular trend that started in 1981 and almost certainly ended in 2021:
Both the increases in the Fed funds rate and long term Treasury rates definitively broke those long term trend lines in the three years since.
And if there is going to be inflationary fiscal policy, and accommodating monetary policy, there is every reason to believe that we have started a new secular era that will be much like the era from the 1950s through 1981, which featured both increasing Fed interest rates and increasing inflation:
It is hard to imagine housing making any kind of strong positive contribution to the economy with those headwinds, unless by some miracle middle and working class incomes increase faster than inflation on a sustained basis.
