To have a clear view on where inflation may be heading, it is therefore worth understanding how the rental market is faring.
The December CPI print was a welcome surprise to many investors, showing a monthly contraction in headline prices and a modest move higher in core prices. This result was the continuation of a trend now many months old – both headline and core inflation seem to have peaked. However, while broader inflationary pressures have eased, there remains one persistently sticky inflationary component which is increasingly accounting for the lion’s share of CPI growth: shelter.
Shelter is the largest single component of CPI, accounting for 32.7% of the bucket. Of this, it is comprised of the smaller “Rent of primary residence” component and the much larger “Owners’ equivalent rent”, or OER. OER measures how much money a property owner would have to pay in rent to be equivalent to their cost of ownership, and as such is not an observable variable (like, for example, the price of a gallon of milk). Instead, it is calculated by asking property owners what they would be willing to pay to rent their homes. As a result, the strength of the rental market feeds through to both rent and OER.
To have a clear view on where inflation may be heading, it is therefore worth understanding how the rental market is faring. According to Zillow, rents surged in 2021, likely as landlords recognized that government stimulus programs had left many Americans flush with cash. Now, these rents appear to be coming off the boil. In some of the country’s largest cities, like New York and Houston, rents have been falling for the last several months; and at a national level, price appreciation appears to have plateaued, with the most recent two readings showing modest 0.1% monthly increases.
Given that pandemic-era stimulus has largely dried up and that Americans have started dipping into their savings to spend – including on rent – it seems possible that national rents will start to fall in the coming months. However, even if they do not and the trend of only gradual price increases continues, the implied year-over-year growth rate in rent should fall below 1% by October of this year, the first such reading since October 2020.
For investors looking for signs that inflation will continue to cool, this outlook for the rental market should be celebrated. Moreover, it may help to encourage a change in Federal Reserve policy, suggesting that the end of the hiking cycle may be sooner than currently projected.