CPI Not Capturing Housing Inflation

Despite the meteoric rise in housing prices, most other gauges of inflation are indicating robust, but not out-of-control price increases. There is an ongoing debate about whether inflation will persist for the long-term or whether it will spike in the short-term and result in being just a transitory adjustment to the 2020 pandemic induced decline.

One area that seems to be out of step with the inflation data is owners equivalent rent, which is the metric used within the consumer price index to measure changes in the price of housing. OER, as it is often called, measure the amount of rent one would pay for a home if they rented it instead of owning it. The problem with this metric is that it does not take into consideration rapid price increases, like the ones we have been witnessing as of late.

That might be due to change. OER stopped falling recently and may soon reverse course and rise along with the Case-Shiller 20 city index. There is usually a lag between the time when real estate prices rise and the subsequent increase in rental rates. But while that lag is usually 18 months or so, some economists are predicting the lag could be considerably shorter this time around.

So far, CPI is already trending above consensus forecasts even without an increase in OER. If OER suddenly spikes to over 4%, future CPI consensus forecasts could continue to underestimate inflation.

While the debate over whether inflation will be transitory or not won’t be settled until enough time passes to identify a winner, no one seems to be talking about the potential for inflation to be well above expected levels – even if only over the short-term. If so, not only could it be self-fulfilling to long-term inflation – it could also be quite damaging in the short-term.

My portfolios continue to hold commodities like Gold, copper, TIPS, and Energy, in anticipation of upside risks to inflation.