A look into Shelter Inflation

And when it will peak...

By now we all know that about 30% of the Consumer Price Index (CPI) is Shelter. Despite headline inflation abating to a YoY change of 7.7% from 8.2%, we saw a month on month increase of 0.4%. Part of the increase was driven by Shelter inflation.

The question then on everyone’s mind is: “when will shelter inflation decrease?”

I dug into the data a little bit to try and figure this out.

I posted this chart in an earlier post, right after the CPI data came out. The chart shows us quite clearly that the Shelter numbers continue to increase month on month. Now, while they seem like very small numbers they still lead to a substantial change in the CPI mainly because of the weighting.

What’s in the Shelter CPI?

Let’s have a quick look at what constitutes shelter inflation and a few of the more important terms associated with it.

The largest portion of shelter is influenced by Owners’ equivalent rent of residences (OER) and rent of primary residence (rent).

Owners’ equivalent rent (OER)

This is based on owner-occupied housing and data is collected during the Consumer Expenditure Survey with answers to the following question:

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

Rent

Data is collected during the Housing Survey from consumers who rent their primary residence with answers to 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?”

According to BLS, the CPI program collects rent data from each sampled unit every 6 months. Many rents change infrequently, being locked in place for a given lease term, and collecting rent data less frequently allows for a larger sample.

There’s a lot of debate on the methodology employed for these items. Since, it’s really the only official, widely acceptable data we have on CPI coming from the Bureau of Labor Services, we’ll just use it.

When could Shelter Inflation Peak?

We’ve had a look at some the statistics on rent coming out in the last few months. As of August - September, rent has been coming down. But, rental contracts can be for up to 2-year periods and therefore, we wouldn’t exactly see the change immediate. There’s also some smoothing in the data and by the time that makes its way into the system, it’s usually a period of 4-6months.

Source: Goldman Sachs Macro Update

I looked into the housing market in general to correlate it to the shelter inflation statistic. I compared Shelter CPI to the Case-Shiller National Home Price Index and made some notes.

What this suggests:

• Shelter CPI does follow the Case-Shiller Index, albeit with a time-lag

• The time-lag between a peak in the Case-Shiller and the Shelter CPI varies between 14 months and 18 months

• The average of these time lags comes out to roughly 15.8 months.

• Given that the Case-Shiller peaked in April 2022, this puts us roughly in August 2023 in terms of the Shelter CPI peaking.

Closing Thoughts

I can imagine that this correlation may not hold up with any kind of certainty. There’s also the fact that the aggressiveness of the Fed’s hiking cycle may actually accelerate the process of bringing down inflation which is what they are trying to achieve anyway.

Goldman Sachs predicts a peak in shelter inflation around April 2023, as we in the dark blue shaded area in the chart below.

I estimate that we see the peak coming sometime around May and with that a meaningful decline in the levels of inflation.