The Fed was waiting for the right data. The turning point is almost here.

The rebound in consumer prices at the start of 2024 has raised concerns that the last mile of the road back to the Fed’s 2% inflation target will be the most difficult. Market participants concluded that inflation was “stuck” and pushed their expectations for interest rate cuts higher, sometimes even considering the possibility of no cuts at all. The main sticking point has been housing inflation, which remains about 2.3 percentage points above its pre-pandemic pace. But April inflation data, along with leading indicators, suggest that progress on this front may resume.

This means that the long-awaited moderation in housing inflation may be back on track, which should be largely reassuring to Fed policymakers.

Housing carries a heavy weight in key measures of consumer inflation. It makes up 34% of the Consumer Price Index and 15% of the Personal Consumer Expenditure Price Index, the Fed’s preferred measure of consumer inflation. In both indices, the weight reflects the rent paid by renters and the rent equivalent to homeowners. The latter depicts what a homeowner would pay if he rented his own home. Price changes are calculated from a large sample of apartment rentals. These costs have been on a wild ride over the past five years.

The pandemic has radically changed decisions about where to work and live. People wanted more and different types of living spaces. Many had the means to pay for it, thanks in part to financial support as well as a strong recovery from the pandemic. The result was a historic increase in apartment rents in 2021 and 2022, which continues to have ripple effects in official inflation statistics.

Meanwhile, the past few years have also witnessed a boom in apartment construction. As a result, pressures on rents eased. Most measures of rents charged on new leases – so-called market rents – stopped increasing at the end of 2022 and are now rising in line with or slower than their pre-pandemic pace.

However, this slowdown in market rent increases has not been fully reflected in the CPI. CPI housing inflation was 5.7% in April, compared to a pre-pandemic rate of about 3.3%. The disconnect is that the CPI tracks the rents paid by all renters (average rents) and not just what landlords charge new tenants. Over time, rents charged for lease renewals tend to converge to market rents, as landlords and tenants renegotiate. The main reason official measures of housing inflation remained high is that this convergence was still underway.

The transition to cooler rental dynamics in the CPI has taken longer than many people expected. Historically, market rent measures have led official measures of housing inflation by about two to four quarters, suggesting that we should have seen a further slowdown by the end of 2023. Instead, increases in housing CPIs slowed significantly in the first half of 2020. 2023. Since then it has moved largely sideways. This has led some market participants and policy makers to question their expectations of low inflation in the housing sector.

There is every reason to believe we are close to a turning point. For a while, lease renewals were still keeping pace with the surge in rents due to the pandemic, but most indicators show that average rent levels have now fully caught up with this rise. If the catch-up period ends, the pace of increase in average rents is expected to slow further in the coming months.

The longer than usual period of convergence has led some to question whether the stability of market rents will be fully reflected in official measures of housing inflation. Skeptics point out that privately produced measures of market rents are based on different samples than the CPI and may not be representative of the entire U.S. urban population. Government researchers have begun publishing an index of new tenant rents calculated from the same sample as the CPI, confirming that average rents have reached market rents as of the fourth quarter of 2023. The NTR is subject to revision, but the latest data points are usually subject to review. For larger revisions, subsequent revisions will be smaller. It is worth noting that the convergence in the fourth quarter of 2023 remains in place after a round of review.

Given the widest possible range of information available, it is probably only a matter of time before we see housing inflation slow further and overall inflation returns to the Fed’s 2% target. The April CPI report confirmed further progress: tenant-occupied rent rose 0.35% from the previous month, representing the slowest pace of increase since August 2021, just before we entered a period of superlative rent growth.

Our reading of the basic details is that the slowdown in market rents is resuming in official inflation data after a pause in the second half of 2023. The Fed said it “does not anticipate that it will be appropriate to reduce… [interest rates] To gain greater confidence that inflation is moving sustainably towards 2%. Many areas outside of housing are already showing significant progress. A downward move in housing inflation is likely to be the confidence boost the Fed has been waiting for.

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