CPI and inflation data

[Zach Wain]

Hello BP'ers,

Today, another monthly inflation report came out, the nations December CPI.  Consumer Price Index.  Headline (total) inflation was negative, -0.1% M/M, which is a great thing to see.  Mostly driven down by food and energy prices.  Core CPI, which removes volatile food and energy was up 0.3%.  This is watched more closely by the Fed than headline CPI.  0.3% is a touch high, but 0.1%-0.2% M/M is what the Fed wants to see on avg, so overall, not bad.  Here is the real kicker, Shelter costs, which is about 32% of the entire CPI report was up 0.8% M/M.  It sounds crazy, but this was expected.  The metrics used by the US Bureau of labor statistics to measure housing/shelter costs is Bananas!  It lags real time data by 6-12 months.  But, this is the system that is place.

OER, Owners Equivalent Rent survey is a very lagging way to assess our housing costs, and that is 24% of the 32% of the Shelter component.  The other 8% is an actual rent survey, but its still measured in a Y/Y lease comparison so even that lags as well.

The Good news, is that in 3-9 months its likely that the Shelter component will finally flip to negative (even if home prices start leveling off and/or start moving higher).  My opinion, is that in Q3 the Y/Y CPI numbers will be sub 2%.  That is a bold prediction and most economists think 3.5%-4.5% range.  But, I think we will hit negative shelter costs, along with most other prices continuing to come down.  This assumes the supply side continues to open up and China does not shut down, or other curveballs cause supply issues.  The Avian flu is not helping egg prices right now for example.

For example, the past 3 months Core CPI minus Shelter is -1.0%.  If that trend continues and shelter costs start to flip to neutral or negative, we might get a nice surprise.  When inflation comes down, so do mortgage rates.  Q2/Q3 I think mortgage rates continue a slow trend lower.  I also think the Fed wants to fight mortgage rates from dropping too low because they do not want to stoke the housing market again.  Anything below 4.5% for a con 30 yr fixed and I expect the Fed to fight back, just a guess...  But since mortgage rates have 1%-1.5% to fall before that happens, we have some leeway.