The third consecutive 75-basis-point (0.75%) interest rate hike by the Federal Reserve is in the rearview mirror. Yesterday’s announced move, which was generally expected by the market, still drove stocks lower. That’s mostly because comments from Fed Chairman Jerome Powell were more hawkish than expected. Indeed, his comments around shelter inflation have raised investor eyebrows, as consumer price index (CPI) numbers have continued to come in hot.
Shelter inflation, or the effect of shelter costs on the overall CPI, has driven a great deal of the recent moves in CPI. With gasoline and fuel costs declining substantially, many had priced in a CPI reduction during the most recent report. However, higher-than-expected shelter inflation led to a small — but symbolic — uptick in this key metric.
Why is that?
Well, housing costs account for roughly one-third of the overall CPI index. It’s generally the biggest-ticket item on most households’ spending budgets. Accordingly, how housing costs change over time means a great deal more than gasoline prices. This is a notable reality, considering it’s not as visible a daily reflection of inflation as filling up every week.
Let’s dive more into what shelter inflation is and why it matters so much.
What Is Shelter Inflation?
The consumer price index factors in shelter inflation in an interesting fashion. Instead of measuring the absolute price increases of the median home price across the country, a measure called “owners equivalent rent” is used. This attempts to measure what, in theory, a given house would rent for on the overall market. That’s because housing costs to homeowners and renters can vary substantially, and this variation makes measuring the true housing cost for individuals difficult.
Most homeowners, and renters for that matter, have noticed that prices are going up. Whether we’re talking detached homes, condos or rental apartments, costs are skyrocketing. Much of this has to do with higher prices, but also higher mortgage rates, which are the result of Fed tightening.
Interestingly, the higher the Federal Reserve raises its benchmark interest rate, the higher mortgage costs tend to appreciate. New homebuyers, or renters looking to pay someone else’s mortgage, will see their costs go up over time.
The thing is, for shelter inflation to come down, housing prices generally have to come down first. That’s because rents tend to lag behind housing prices. Accordingly, with obscene surges in property values of late, this may take some time.
Jerome Powell noted this reality in his speech, and reaffirmed his plan to “hope for the best, plan for the worst.” Right now, the market appears to be bracing for the worst.
On the date of publication, Chris MacDonald did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
