US headline Consumer Price Index (CPI) inflation rose from 2.4% year-on-year (YoY) in September to 2.6% in October, while core CPI inflation remained constant at 3.3%. As the table below indicates, the reason headline and core inflation are so slow to decline is that the shelter component, which has a weight of 36.5% in the CPI, is so strong, rising 4.9% YoY. Disregarding shelter, core CPI inflation remained at 2.0% in October.
Investment Insights • MFN
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The slow decline of US shelter inflation
The latest US inflation data has pointed to a slow decline, however much of this has been due to strength in the shelter component. In this Macro Flash Note, Chief Economist Stefan Gerlach takes a closer look at this factor.
Table 1. US CPI Inflation in October
Source: SA data from BLS. Data as at 13 November 2024.
It is well known that the shelter component is problematic because it lags the current cost of shelter. The chart below shows the annual percentage change in the shelter component and the annual percentage change of the Zillow Observed Rent Index, which provides a timelier measure of the cost of shelter.
The chart shows that shelter inflation reacts with a long delay to changes in market rents. The rate of shelter inflation has been declining slowly since April 2023 and stood at 4.9% in October, still much above the 3.3% average in the period 2016-19. In contrast, the Zillow index started falling in March 2022 and reached 3.3% in October, which is well below the 4.1% average between 2016-2019.
Chart 1. Annual growth rates
Source: EFG calculations on data from FRED and Zillow. Data as at 13 November 2024.
It is possible to estimate how quickly changes in the Zillow index take to feed through to the shelter component of the CPI. This is illustrated in the chart below, which shows an estimate of how a permanent one percent increase in the growth rate of the Zillow index impacts the growth rate of the shelter CPI component.1 The time it takes for half of the passthrough to take place (the median lag) is estimated to be about 20 months. The shelter component is indeed lagging far behind market developments. The slow passthrough implies that shelter inflation will remain high for some to come.
Chart 2. Estimated passthrough
Source: EFG calculations on data from FRED and Zillow. Data as at 13 November 2024.
Disregarding this measurement issue, a plausible argument can be made that the US has returned to price stability, although that will only become apparent gradually in the headline and core inflation rates. Declining shelter inflation will be one factor that speaks in favour of continued Federal Reserve rate cuts in the coming months.
Of course, other factors could slow or stop the decline in inflation, in which case the Fed may decide to delay or cease interest rate cuts. We continue to believe that the behaviour of the labour market will be critical in this regard.
1 The passthrough is estimated by regressing the annual inflation rate for shelter on the growth rate of the Zillow data and a lagged dependent variable, and imposing a unit long-run passthrough (which fits the data well).