2022 Theme: Persistent & Rising Rental Inflation
Rental inflation in the US could just be getting started. We argue that this will be a big theme of the US economy in 2022 and will contribute to higher inflation than many economists and analysts have expected.
Here is why.
Last week, we had a few questions around our post on rising home prices not yet showing up in rents.
There were a few different angles but the general gist was:
What do you mean rents will go up, have they not gone up already?
This is, of course, true! Rents did rise in 2021 vs the lows of 2020.
The number was actually over 10% nationally - your neighborhood/district/city/state may be quite different, of course.
And shelter inflation (or how much it costs to put a roof over your head) is fully one third of CPI, as we mentioned last week.
However, house prices also rose steeply in 2021. In fact, nationally, they rose over 17%. So significantly more than 2020.
This means that rents are likely to continue to rise in 2022. Perhaps by quite a bit. Rental inflation has an inherent time lag attached to it.
And fully 75% of that rise has yet to show up in inflation numbers because the Consumer Price Index (the CPI was are always banging on about) weighs rents, far more than home prices, as a component in the cost of shelter.
These facts have stoked the expectation that rents could continue to rise and reach heights not experienced in over a generation. We are already at the highest rental inflation in over 30 years.
The time lag is simply because many - not all but many - US rental contracts are a year long so you lock in your rent for a long time, of course.
This adds both a delay and a lumpiness to the data. There can be relatively muted rental inflation for many months and quarters until a rental cliff arrives and a large plurality of contracts must be resigned at a higher rate.
There are a lot of people expecting an acceleration in this rent and, when it does that it may continue to keep US CPI inflation high even if interest rates rise and, more importantly, some components decline.
Well because rental inflation doesn't just have a lag. Rents are also what economists term as very sticky prices.
The reason for their "stickiness" is pretty clear. Once set, rents can't just come down overnight like the price at the pump or other basic commodities. They are stuck at a certain price for a while and, like wages, are difficult to see major declines without something dramatic occurring.
No one goes into work and is willing to suddenly take a pay cut. For similar reasons, landlords are very reluctant to renegotiate the price of their apartment or home at a significantly lower price point.
So, what do higher expectations of rental inflation mean?
Put it all together and it suggests two likely outcomes:
Rents may rise significantly in the next few quarters as old leases expire and new contracts are signed.
This may make it far harder for the US inflation rate to come down as the rental component of US CPI lurches upwards.
In others words, 75% of a third of US inflation is a lot and this could keep it elevated against the grain of expectations and economic logic.
In other words, come this summer these conditions could be true:
US interest rates may be (far) higher,
The cost of mortgages could be more expensive
And yet the headlines could still be screaming about high inflation.
The last point doesn't have to be purely about rents either. We have beaten the energy drum for many months after all.
But the very core-ness and stickiness of rental and shelter inflation could mean that a lot of the non-sticky components (think about supply chain related items) from the last year could come down while the far more problematic "sticky CPI" components could be taking over.
This could keep CPI elevated. A very impressive analysis by economists the San Francisco Federal Reserve branch suggest that this could be worth as much as a full percentage point of CPI over the next two years.
(that is a lot. Here is the paper.)
Helpfully the Atlanta Fed divides the CPI into the two components. See here:
It is charts like the above that will be focusing minds and raising the blood pressure of the Federal Reserve's central bankers and their peers, all over the world.
Now you are hopefully forewarned and this will help you stay forearmed.
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