Weekly Economic Trends and Indicators

The Headline:

On Thursday, the Bureau of Labor Statistics (BLS) reported that the Consumer Price Index (CPI) rose by 0.3 percent on a seasonally adjusted basis in December. The BLS also announced on Friday that the Producer Price Index (PPI) for both final and intermediate goods had decreased in December for the third straight month.

The Details:

Within the category of food, the fastest-growing prices were meat, poultry, fish, and eggs (0.5 percent). Electricity prices (1.3 percent increase) contributed to a 0.4 percent increase in the energy category. However, the continued increase in shelter prices (0.5 percent in December and 6.2 percent for the year) had a significant impact on the headline inflation number due to shelter’s large proportion of household budgets (and therefore its larger weight in the CPI). Shelter accounts for 35 percent of the weight in the CPI.

The Context:

While December’s CPI inflation was higher than expected, the markets did not seem to be troubled by the news. Food and energy prices are notoriously volatile, and inflation in those categories has mostly been trending lower. Most categories of core inflation have also been moderating nicely. Shelter seems to be the most stubborn component of inflation, and it weighs heavily on the headline number.

Paradoxically, at least part of the reason for the increase in housing values is the interest rate increases that were intended to cool down inflation. This is because many potential sellers are reluctant to give up the low mortgage rates that they locked in years ago. As a result, the supply of existing homes on the market is reduced.

The current cycle is unusual in terms of the speed and magnitude of interest rate increases. The last time we saw rates increase so much so quickly was in the late 70s and early 80s. At that time, there was less reduction in supply of existing homes because many mortgages were assumable, meaning that the new buyer could simply take over the existing mortgage with compensation to the seller. The Garn-St. Germain Act in 1982 made conventional mortgages “due-on-sale.” Today, only government insured mortgages are assumable (with a few exceptions).

With mortgage rates more than doubling in less than two years, the lock-in created by due-on-sale mortgages is significant. Sellers of starter homes may require their home value to nearly double before it fully compensates them for today’s higher rates. In time, this effect should subside as people will only hold off so long before trading up to new home (and as interest rates eventually moderate). Until then, inflation could read high due to this rarely seen phenomenon.

Next week: Manufacturing update