The Federal Reserve's “last mile” of fighting inflation is being strangled in the throat by rents.

Recently, Nick Timiraos, a Wall Street Journal reporter known as the “New Federal Reserve News Agency,” wrote that high rents are hampering the Federal Reserve's fight against inflation.

The article explains that since the weight of housing inflation is as high as one-third of the CPI index and one-sixth of the PCE price index, it has a huge impact on overall inflation. However, in housing inflation, housing prices will be affected by investment factors, and rents can better reflect the actual situation in the market, so the latter is more critical than the former.

Timiraos said in the article that soaring rents during the pandemic have largely boosted inflation. Currently, rent inflation is still at a high level, but it is showing a downward trend.

During the pandemic, against the backdrop of strong demand and revenue and historically low housing inventories, the rent index for newly signed contracts soared for a while. According to some data, rents for single-family homes (the main body of US housing) rose 14% in 2022.

Subsequently, strong demand for newly built condominiums was diverted from the single-family housing market, inflation-adjusted income growth cooled down, and single-family home rents began to decline.

Since most tenants' rents only change once a year, the implementation of new lease rents is lagging behind. According to available market rent data, Federal Reserve officials, Wall Street investors, and private sector economists believe that housing inflation has slowed since the end of 2022.

Since this year, “stagnant” inflation data, especially core inflation, does not seem to affect the Federal Reserve's plans to cut interest rates during the year. The article explains that because the Fed is confident that housing costs will eventually slow down and push inflation down to 2%.

Wall Street heard this earlier. Steven Englander, chief foreign exchange strategist at Standard Chartered Bank, said in a recent report that if you closely observe housing costs, especially the CPI indicator related to housing inflation — equivalent rent (OER) for owner-occupied owners (OER), you will find that there is reason to optimistically expect that housing inflation may decline soon and drive core inflation downward.

On Wednesday, the US Bureau of Labor Statistics will announce the April CPI. Currently, economists generally predict that the CPI will slow slightly to 3.4% in April from 3.5% in the previous month, and the core CPI will also slow down from 3.8% to 3.6% year over year.

How much does rent inflation need to be reduced?

Since the rent slowdown is the key to reducing the core inflation rate to the Federal Reserve's target, how much does rent inflation actually need to be reduced?

Looking at each item, the article divides core inflation into three sub-categories: commodity inflation, housing inflation, and non-housing service inflation.

The article points out that before the epidemic, the commodity inflation rate was about -1%, the housing inflation rate was about 2.5%-3.5%, and non-housing service inflation was slightly higher than 2% — the overall core inflation rate was slightly less than 2%.

Therefore, if the inflation rate is to return to the 2% level, the inflation rate for non-housing services must be reduced from the current 3.5% to less than 3%, and the housing inflation rate must be reduced from 5.8% to about 3.5%.

The “last mile” is not easy to walk

However, there are still opinions that the prospects for declining rent inflation are not that optimistic.

The article said that many economists believe that the downward trend in new lease rents in recent years will indeed drive housing inflation to cool down, but this process will take longer than expected. Timiraos explained:

“Because of the impact of high interest rates, the desire of more residents to buy homes is sluggish, and the demand for rent renewal is higher. This could prolong the time it takes for new lease rent declines to be reflected in overall inflation.”

Another major risk is that new condominiums have also fallen into a tight supply and demand situation.

Wall Street heard this earlier. Compared with apartments, housing inflation is more likely to be affected by single-family housing rents because the latter is the main body of housing in the US. An important reason for the slowdown in rents in recent years is that the supply of newly built apartments has increased rapidly, diverting strong demand for single-family homes.

However, the article points out that some industry executives said that due to increased immigration and steady growth in employment and wages, demand for newly built apartments is accelerating again, which may cause the single-family housing market to heat up again.

According to data from real estate company Camden Property Trust, the percentage of tenants moving out of its apartments has now dropped to 9%, the lowest level in 30 years for the company. Generally speaking, the normal eviction rate is at the level of 15% to 18%.

The company's CEO Ric Campo said:

“The reality is that there is much more demand than most people expected.”