The last couple of US inflation readings came in well below expectations, showing a dramatic acceleration to the downside in the inflation rate. In fact, inflation for November was recorded as lower than in January. December might prove to be a bit of an exception because of the demand distortion around the holidays.
But, the value of the dollar is tied to the expectation of the Fed’s rate policy in the months ahead. Which in turn is largely predicated on where inflation is headed. One of the main questions is whether the Fed will keep rates high as the economy slows. If inflation remains high, the chances of a Fed “pivot” fade. However, there is an indicator here which could show increasing downward pressure on inflation, which could allow the Fed a little more room for dovishness.
First, we need to distinguish between core and headline inflation. The latter is driven in large part by increasing energy costs, which tend to be more volatile. Headline inflation has been coming down in line with fuel prices. But the Fed generally ignores this indicator, and focuses more on the core rate, which doesn’t account for energy or food costs.
Diving a little deeper into the core inflation data from the last couple of months, we can see that the largest contributor to the drop was a cooling real estate market. CPI figures don’t take into account the cost of houses, but do consider rent. And rent prices have been slowing down dramatically in line with slower home sales, as interest rates push up the cost of mortgages.
The new data
The presumption is that core inflation will continue its slide if rent prices continue their current trend. And a new gauge developed by the Federal Reserve Bank of Cleveland points in that direction. This indicator looks at the change in the amount of rent paid by new tenants and compares it to existing tenants. Essentially, it measures how much people are paying to rent a new place compared to their current rent prices.
Rent prices rise slowly, as it takes time for landlords and tenants to negotiate new contracts. But prices of rent coming on the market can fluctuate quite quickly. If there is demand, then the price of new contracts will rise quickly. If there is less demand, then the price of new contracted rents will drop. That’s even if landlords raise asking rent; it won’t be reflected in the data unless a contract is actually signed.
The trends and the future
What the indicator shows is that new rental contracts spiked through 2021 and early 2022, showing that people were renting at as much as 13% higher prices than the prior year. But, since September, those price increases have started to come down dramatically.
People are still paying significantly higher rental prices, at a growth rate of 5% compared to the prior year in November. But the trend is showing an even faster fall than the rise in prior years. In fact, it’s the fastest drop on record.
If the trend maintains, it could contribute to core inflation coming in below expectations once again. That, in turn, could give the Fed more reason to keep rates from rising as high, and potentially allow room for a pivot to the downside at some point.