The Federal Reserve may have a housing problem. At the very least, it has a housing riddle.
Overall inflation has eased substantially over the past year. But housing has proved a tenacious — and surprising — exception. The cost of shelter was up 6 percent in January from a year earlier, and rose faster on a monthly basis than in December, according to the Labor Department. That acceleration was a big reason for the pickup in overall consumer prices last month.
The persistence of housing inflation poses a problem for Fed officials as they consider when to roll back interest rates. Housing is by far the biggest monthly expense for most families, which means it weighs heavily on inflation calculations. Unless housing costs cool, it will be hard for inflation as a whole to return sustainably to the central bank’s target of 2 percent.
“If you want to know where inflation is going, you need to know where housing inflation is going,” said Mark Franceski, managing director at Zelman & Associates, a housing research firm. Housing inflation, he added, “is not slowing at the rate that we expected or anyone expected.”
Those expectations were based on private-sector data from real estate websites like Zillow and Apartment List and other private companies showing that rents have barely been rising recently and have been falling outright in some markets.
For home buyers, the combination of rising prices and high interest rates has made housing increasingly unaffordable. Many existing homeowners, on the other hand, have been partly insulated from rising prices because they have fixed-rate mortgages with payments that don’t change from month to month.
Housing prices and mortgage rates don’t directly show up in inflation data, however. That’s because buying a home is an investment, not just a consumer purchase like groceries. Instead, inflation data is based on rents. And with private data showing rents moderating, economists have been looking for the slowdown to appear in the government’s data, as well.
Federal Reserve officials largely dismissed housing inflation for much of last year, believing that the official data had simply been slow to pick up on the cooling trend apparent in the private data. Instead, they focused on measures that exclude shelter, an approach they saw as better reflecting the underlying trends.
But as the divergence has persisted, some economists inside and outside the Fed have begun to question those assumptions. Economists at Goldman Sachs recently raised their forecast for housing inflation this year, citing rising rents for single-family homes.
“There’s clearly something that’s happening that we don’t yet understand,” Austan Goolsbee, president of the Federal Reserve Bank of Chicago, said in a recent interview. “They ask me, ‘What are you watching?’ I would say, ‘I’m watching housing because that’s the thing that’s still weird.’”
Lagging Data
The stubborn nature of housing inflation isn’t a total mystery. Economists knew it would take time for the moderation in rents seen in private-sector data to make its way into the Labor Department’s official Consumer Price Index.
There are two reasons for that delay. The first is technical: The government’s data is based on a monthly survey of thousands of rental units. A given unit is surveyed only once every six months, however. So if an apartment is surveyed in January and the rent goes up in February, that increase won’t show up in the data until the apartment is surveyed again in July. That causes the government data to lag behind conditions, especially during periods of rapid change.
The second reason is conceptual. Most private indexes include rentals only when they get new tenants. But the government aims to capture housing costs for all tenants. Because most leases last a year or longer, and because those who renew their leases often get a discount relative to people renting on the open market, the government’s data will typically adjust more gradually than the private indexes.
The public and private data should eventually converge. But it isn’t clear how long that process will take. The rapid rise in rents in 2021 and 2022, for example, led many people to stay put rather than wading into the red-hot rental market. That, among other factors, may have made it take longer than usual for market rents to filter into the government data.
There are signs that a slowdown is underway. Rents have risen at an annual rate of less than 5 percent over the past three months, down from a peak of close to 10 percent in 2022. Private data sources disagree on how much rental inflation still has to ease, but they agree that the trend should continue.
“For the most part, they’re all saying the same thing, which is that rent inflation has moderated significantly,” said Laura Rosner-Warburton, senior economist at MacroPolicy Perspectives, an economic research firm.
Houses vs. Apartments
While rental inflation may finally be moderating, the government’s measure of costs for homeowners has not followed suit; it actually accelerated in the latest month’s data. And because more Americans own their homes than rent, owner-occupied housing dominates the shelter component of the Consumer Price Index.
The expenses that most people associate with homeownership — mortgage payments, homeowners’ insurance, maintenance and repairs — aren’t directly included in inflation measures.
Instead, the government measures housing inflation for owners by assessing how much it would cost to rent a similar home, a concept known as owners’ equivalent rent. (The idea is that this measures the value of the “service” of providing a home, as distinct from the investment gains from owning it.)
The rental and ownership measures ordinarily move together because they are based on the same underlying data — the survey of thousands of rental units. But to calculate the ownership figures, the Labor Department gives greater weight to homes that are comparable to owner-occupied units. That means that if different types of housing behave differently, the two measures can diverge.
That could be what is happening now, some economists say. A boom in apartment construction in recent years has helped bring down rents in many cities. Single-family homes, though, remain in short supply just as millions of millennials are reaching the stage where they want more space. That is driving up the cost of houses for both buyers and renters. And because most homeowners live in single-family homes, single-family units play an outsize role in the calculation of owners’ equivalent rent.
“There’s more heat behind single-family, and there’s very good arguments to be made for why that heat will persist,” said Skylar Olsen, chief economist at Zillow.
A Fluke, or Something More?
Other economists doubt that the uptick in inflation in January is the start of a more lasting trend. Single-family home rents have been outpacing apartment rents for a while now, yet only recently has inflation for owners and renters diverged. That suggests that the January data was a fluke, argued Omair Sharif, founder of Inflation Insights, an economic research firm.
“The month-to-month stuff in general can be choppy,” Mr. Sharif said. The good news in the report, he said, is that rent growth has finally begun to cool, making him more confident that the long-awaited slowdown is emerging in the official data.
That conclusion is far from certain, however. Before the pandemic, different parts of the housing market told generally consistent stories: Rents for apartments rose at roughly the same rate as those for single-family homes, for example.
But the pandemic destroyed that equilibrium, driving rents up in some places and down in others, disrupting relationships between the different measures. That makes it hard to be confident about when the official data will cool, or by how much — which could make the Fed more cautious as it considers cutting interest rates, said Sarah House, senior economist at Wells Fargo.
“Right now, they’re still assuming that there’s still a lot of disinflation in the pipeline, but it’s going to keep them guarded in their optimism,” she said, referring to Fed officials. “They do have to think about where shelter actually lands, and how long it takes to get there.”
