April 2019 CPI Inflation

We appear to be seeing a rebound in shelter inflation and a decline in non-shelter inflation.  The inverted yield curve, stabilizing home prices, declining residential investment, and a peak in existing and new home sales all suggest parallels to 2006.  This is now three consecutive months with core non-shelter deflation.  (Caveat: there were some parallels to 2006 two years ago, too, so follow my logic with a grain of salt.)

As in 2006, these conditions are generally related to marginally contractionary monetary policy.  In 2006 and 2007, consumption was able to continue growing in spite of monetary contraction because the housing bubble had provided trillions of dollars in home equity to draw upon for liquidity.  The housing ATM postponed our self-imposed recession.  There isn't much of a housing ATM available today.  On the other hand, what made the recession Great was the late and extreme tightening of credit access that created a post-2008 default crisis and wealth shock targeted among low tier home owners.  You can't kill a dead horse, so on that front, there is safety relative to 2006.  There's a good slogan for proponents of macroprudential credit controls.  "You can't kill a dead horse!"  Though, as rising rent inflation makes clear, you can continue to kick it.

As has been the case for most of the last 20 years, rent inflation for tenants has been running higher than rent inflation for owners. Additionally, credit markets have been suppressed for the last decade, pushing prices down.  This created a wealth shock for owners during the transition to the new normal where housing markets are characterized by federal exclusionary rules.  But, as we move away from that one-time effect, the low price of homes for families that are "qualified" under the new regime becomes something of a rent subsidy for "qualified" owners.  The rental value of their homes is rising, but since credit suppression provides them with excess returns on their investment, those rising rents aren't reflected in rising mortgage payments, so that their spending isn't as constrained in other types of consumption.  In spite of this, inflation in non-shelter core components is still barely running above 1%.

It continues to appear to me to be the case that we have finally entered the period of time where the Fed will keep the target rate steady, creating a plateau period where the yield curve is inverted.  The curve will fluctuate somewhat during this time, but it will remain inverted.  It is unlikely to un-invert unless the Fed proactively lowers the target rate.  Eventually, the target rate will be biased enough toward contraction that the Fed will have to start chasing the neutral rate down, and everyone will declare those rate cuts to be stimulative, even though they will really reflect a Fed policy that is just walking backwards more slowly.

In the recent press conference, Fed chair Powell said, "Overall inflation for the 12 months ended in March was 1.5 percent. Core inflation unexpectedly fell as well, however, and as of March stood at 1.6 percent for the previous 12 months. We suspect that some transitory factors may be at work. Thus, our baseline view remains that, with a strong job market and continued growth, inflation will return to 2 percent over time and then be roughly symmetric around our longer-term objective."

Employment is a lagging indicator.  Neither rent nor shelter were mentioned in the press conference.