Overview
How transitory is today’s sharp upward spike in US inflation? Investors and policymakers are all focused on this question; we think shelter holds part of the answer. Back in February 2021 we noted the importance of tracking shelter inflation in the US for forecasting US CPI, given the large weight the shelter component - a measure of housing rents (but not prices) - has in the CPI basket. We noted the strength in home purchase prices as likely to feed into stronger shelter inflation - and we were thus more constructive on shelter and US CPI for the year ahead.
Fast-forward 5 months and this has largely played out. On a year-on-year basis, US shelter CPI reached a trough in February 2021 of 1.5 per cent and has since rebounded, now at 2.6 per cent YoY. Core CPI (stripping out energy and food costs) rose even faster, at a 13-year high of 4.5 per cent in June, following a strong rebound in categories linked to the reopening of the economy, such as airfares, and new and used cars and trucks. We think many of these reopening-focused inflation drivers will prove to be transitory, but shelter is different.
More strength in shelter to come
Shelter inflation tends to be sticky, and therefore it has the potential to mitigate weakness from more transient components of the CPI basket. For example, we don’t expect used car and truck prices to rise at over 10 per cent month-on-month for much longer.
History shows that shelter inflation tends to follow what is happening in the home purchase market, albeit with a lag. While shelter inflation has certainly reversed its pre-Covid downward trend, its rebound has been somewhat muted relative to the dynamics in the housing market (for purchases) and versus history. For example, shelter inflation averaged +3.3 per cent YoY between 2015 and 2019, while today it is +2.6 per cent YoY. Moreover, real-time rental data continues to be robust. Before the year is finished, we may yet see shelter inflation move beyond its peak of the previous cycle.
