So, here’s a thought experiment for you. Is there a case to be made that higher rates actually cause inflation, and that the cure to inflation could actually be cutting rates?
Sounds crazy, right?
I think it’s always good to think through unintended consequences when it comes to monetary policy changes. One of the particularly frustrating parts of this cycle of inflation is shelter. I don’t know if people realize that housing costs make up about one-third of the Consumer Price Index. Shelter includes:
- Owners’ Equivalent Rent (OER): This measures the implicit rent that owner occupants would have to pay if they were renting their homes. It does not include the cost of furnishings or utilities. This is a critical component because it captures the cost of shelter for homeowners in a way that is comparable to renters, without directly pricing the home as a capital asset.
- Rent of Primary Residence: This directly measures the cost of rent for those who do not own their homes but rather rent their living space.
- Lodging Away from Home: This includes costs associated with temporary lodging outside the household, such as hotels and motels.
- Tenants’ and Household Insurance: While this component is more specific, it includes the cost of insurance coverage for renters, focusing on contents coverage within rental housing units.
This has been the problem with inflation. Shelter inflation has been incredibly sticky at 5.7%.
What Is Going on With Shelter Inflation?
A large part of this has to do with the resilience of the housing market, with demand exceeding supply. Why is supply so constrained? Because many homeowners locked in their mortgage rates at considerably lower levels and have no desire to give that up by putting their homes out on the market. 30-year fixed mortgage rates are now averaging 7% — a function of the 10-year yield and interest rate policy.
You know how you unleash housing supply potentially at a faster rate than demand? By bringing mortgage rates down. By closing the gap between the lower, locked-in rates that many homeowners have against a new mortgage rate, incentivizing those homeowners to finally list their homes on the market. This would create a flood of supply and bring prices down.
Sounds crazy? Maybe, but housing really is the biggest and most important issue today, and lowering rates just a bit might be enough to reverse the demand/supply dynamics that have kept shelter elevated for so long.
On the date of publication, Michael Gayed did not hold (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.
