Another Look at Shelter Costs In The Consumer Price Index

Ahead of next week's report, an apparently crabby Real Investment Advice, September 8:

BLS’ Housing Inflation Measure is Hypothetical Bull****

There is a problem with the BLS’ housing inflation measure; it’s hypothetical “Bull****.”

The Case, Shiller 20-city House Price Index, is up 19.1% year over year. The only period with a somewhat comparable increase was in 2005 when it rose 14.9%.

Per Apartment List’s August update: Since January 2021, the national median rent has increased by a staggering 13.8 percent.

With a 30% contribution to CPI, Shelter prices are prone to boost CPI higher in the months ahead.

It seems like a logical conclusion, but is it?

The answer has tremendous implications for investors. If inflation continues to rise from elevated levels, the Fed will be under increasing internal and external pressure to taper QE and raise interest rates. For a market “all ginned up” on Fed liquidity, that is the last thing investors want to see.

So, let’s explore our question and try to answer it. 

Consumer Price Index (CPI)- Shelter

The Bureau of Labor Statistics (BLS) category of Shelter, accounting for 30% of the CPI Index, is broken down into Owners’ Equivalent Rent (OER) at 23% and Rent of Primary Residency at 7%.

Unbeknownst to most people, the BLS only uses rent and rent proxies to calculate CPI. Such is because they believe the prices of houses and other residential structures are financial assets, not consumption items.

Agree or not, that is how they do it.

To calculate OER, the BLS uses the following survey question:

• “If someone were to rent your home today, how much do you think it
  would rent for monthly, unfurnished and without utilities?”

To calculate rent, they use the following question:

• “What is the rental charge to your [household] for this unit including any
  extra charges for garage and parking facilities? Do not include direct
  payments by local, state or federal agencies. What period of time does this
  cover?”

Finally, OER asks homeowners a hypothetical question starting with the word “if.”

Do you know what your home is worth? Do you know how much you can rent it for? Most homeowners have a much better idea of what their house is worth than how much they can rent it for.

Given 23% of CPI is based on a guesstimate of homeowners, does OER have much value in estimating rental prices? In all fairness, the BLS uses data checks and adjustments to improve survey results.

Click HERE for the BLS explanation on how they compute OER and Rent.

OER Is Not Forecastable?

Since 2001, the Case Shiller Home Price Index has been volatile. At the same time, OER has been incredibly stable. From a statistical perspective, Case Shiller is over eight times more volatile than OER. Further, the two data sets have a near-zero correlation with each other.

As we wrote earlier, the BLS does not consider home prices in CPI. However, home prices are a vital component of rent. In addition, most homes get rented with the intent of the homeowner turning a profit. In other words, the homeowner aims to earn more than their maintenance, taxes, and mortgage payments....

....MUCH MORE

Recently:
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Our best guess is a lower CPI print, both headline and core, in next week's report and possibly even for the September numbers in five weeks before the shelter cost increases we have seen and will see really take hold and power the index to, possibly, a full-year 2021 headline rate of 5%.

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