MNI: US Shelter Inflation Cooldown Seen Limited In 2024

Sharp declines in market rent indexes in recent months would suggest U.S. rent inflation will fade quickly over 2024, dragging down core inflation measures and bringing forward the timing of interest rate cuts -- but there are good reasons to be skeptical, Labor Department and former Federal Reserve economists told MNI.

The Bureau of Labor Statistics' New Tenant Rent Index showed market rents plunged in the fourth quarter of 2023, bringing the annual rate to -4.7% from last year's peak of 3.4% in the second quarter. It was the biggest fall on record for the recently-introduced series that goes back to 2005, and would correspond to deflation in CPI and PCE measures of rent inflation later this year.

The national rent index by online rental marketplace Apartment List has also been in negative territory for the past few months, falling 3.5% since August.

"To the extent that you trust the New Tenant Rent Index number, that would create an expectation that there’s deflationary pressure or at least deceleration" in the rent component of the official CPI measures," BLS economist Steve Reed said in an interview. "But every reason that you'd want to interpret it cautiously is here -- the fact it's subject to revision, the fact the sample is unusually small" because fewer people are moving in late fall and winter.

CATCHING UP TO CPI

Over the long run, the BLS's market rent index is a powerful leading indicator of traditional measures of rent inflation, which lag the more timely series by about a year. But the magnitude of the drops in the BLS and Apartment List measures of newly-contracted rents are inconsistent with data from some other private indexes, including Zillow's, which showed a virtually steady 3.3% monthly rise in annual rent growth from August through December.

"It does seem like the move in the New Tenant Rent Index is probably a little outsized," Alan Detmeister, an economist at UBS who previously headed the wages and prices section at the Fed Board of Governors, told MNI. "But this is also adding weight to the view there isn’t a lot of catchup still to do," for rent levels on all units to eventually match rents charged to new tenants.

Zillow's data suggests market rents have increased by 10 percentage points more than owners' equivalent rent (OER) since the start of the pandemic, while Apartment List's index is "getting pretty close to CPI's housing measures," senior housing economist Chris Salviati, who also had an early stint at the Fed Board, said in an interview. By contrast, CPI rent has risen 8 pps more than the New Tenant Rent Index.

"Taken at face value, it would suggest you should see OER starting to drop. But taking it at face value is not the right thing to do," Detmeister said. He expects CPI rent and OER inflation to cool to just "a handful of bps" above its pre-pandemic rate by midyear -- to roughly 30 bps a month from just under 50 bps now -- and 12-month core PCE inflation to ebb to 1.8% by year-end. Housing accounts for about 40% of core CPI and 20% of core PCE. (See: MNI INTERVIEW: Fed Could Cut By May, Inflation Lingers-Kaplan)

DEMAND WANED, SUPPLY GAINED

After rents skyrocketed in 2021 and 2022, growth stalled out in 2023, Salviati said. "We’re in a situation where demand has cooled off over this past year while supply is picking up steam, putting us into a place where our index is showing negative year-on-year growth," he said. "2023 was a very strong year for multifamily construction with the most units hitting the market in decades, and 2024 is going to be even stronger."

The CPI shelter component peaked in early 2023 and inflation has receded faster than the Fed expected. Negative shelter inflation would cause core PCE inflation to sink to 1.5% and core CPI inflation to 1% this year, making it increasingly hard for the Fed to justify keeping rates in restrictive territory, Capital Economics said in a note last month.

Even as BLS's market rent index "has historically been very much in line with the official CPI for rent," BLS research economist Brian Adams told MNI, "This is a bigger movement than seen previously. We’d interpret it cautiously."