The Consumer Price Index accelerated 0.39% m/m with Shelter leading the way, contributing 0.24% to the total m/m increase. On a y/y basis, the headline CPI decelerated modestly from last month’s pace to 8.22% from 8.25%. Shelter contributed 2.18% of the total y/y increase, its tenth consecutive month making a new all-time high contribution.
Source: Macrobond.
Underneath the Shelter component, Owner’s Equivalent Rent has been a significant driver of inflation. As mentioned in a prior post (September 21, 2022), this data is gathered by asking, “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished, and without utilities?” It is a unique measure because it is not actually a cost to the consumer and runs on a lag to more current home prices. While still on a three-month lag, the S&P Case-Shiller National Home Price Index has historically led OER by approximately twelve to fifteen months. This measure has decelerated from 21% y/y in March to 16% in July. However, given the Shelter CPI data collection methodology, it is likely that Shelter remains a significant contributor to CPI over the next six months to a year even if we see weakness in the current housing market (July 27, 2022).
Source: Macrobond.
Turning to market-based indicators, five and ten-year TIPS breakeven rates are both below their peaks. The five-year TIPS breakeven rate is at 2.50, down from its recent high of 3.73 in March 2022. The ten-year TIPS breakeven rate is at 2.40, down from its recent high of 3.04 in April 2022. Five and ten-year inflation swaps are also below their peaks. The five-year inflation swap is at 2.74, down from 3.67 in March 2022. The ten-year inflation swap is at 2.62, down from 3.23 in April 2022. TIPS breakeven rates and inflation swaps are suggesting a slowdown in inflation.
Source: Bloomberg.
The interest rate market is also signaling that inflation will likely not continue to accelerate. The U.S. Treasury yield curve has flattened to historically low levels. The 2y10y curve has been inverted since the beginning of July. The 3m10y curve closed yesterday at -3 basis points, which has occurred leading up to every recession since at least 1990. As the front-end moves higher, pricing in rate hikes, the long-end is more sensitive to longer term growth and inflation expectations.
Source: Macrobond.
As mentioned, Shelter CPI is a lagging indicator, therefore it should not be used as a guide for future inflation expectations and rate movements. The market-based signals are all pointing towards a slowdown in economic activity.
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Senior Economic Analyst
Boyd Watterson Asset Management, LLC
