September 2023 Consumer Inflation and Homebuilders

In July 2021, I wrote in the National Review:

Turning back to 2021, as economic activity normalizes, inflation in many areas — such as, say, used cars — may prove to be temporary. But rent inflation appears to be headed back above 3 percent, where it had been before the pandemic.

If rent inflation begins to drive the broader price indexes higher while other prices moderate, that is good news. It allows the Fed to encourage more building, which will help moderate rent inflation and create quality construction jobs. This is what the Fed could have done when housing construction declined in 2006 and 2007. At that time, though, the depth of our housing supply problem wasn’t well understood. There is no reason to make the same mistake again. What we need, once and for all, is a monetary policy that is stimulative enough to break out of our housing slump.

Come September 2023, it’s almost too funny for me to believe. More recently, I have argued that year-over-year inflation indicators are unhelpful in the current context. Inflation has been under control now for so long that that doesn’t matter any more. It’s on target even looking back a year. Market rent inflation is arguably stabilizing. It may be the case that the Fed did us a solid. The Covid recession didn’t lead to a decline in completed new homes. The Fed might have done what I wrote that they should do.

But, in the meantime, there are well-known lags in the CPI shelter category, so that reported shelter inflation is basically still reporting inflation that really happened a year ago. It looks like my warning in 2021 has come true. And, in the meantime, the CPI excluding the shelter component - aggregate CPI and core CPI - literally both hit right at 2% in the September year over year measures. The gods are toying with me. The Fed did what I asked. They didn’t kill the construction market trying to lower rent inflation. And here we are anyway.

Figure 1

Of course, the market reaction to this and much of the pundit reaction is that there is still work to be done to bring down inflation, that the high inflation reading caused by shelter inflation will keep the Fed target rate higher for longer, that this will raise mortgage rates, and that high mortgage rates will hurt the homebuilders. This led the homebuilders taking a bath after the inflation numbers came out, typically losing around 5% on the day.

Housing demand isn’t particularly constrained by mortgage rates, mortgage rates aren’t particularly driven by Fed rate decisions, inflation that matters is back at 2% and generally declining, and the seemingly high inflation is a known false flag. And, PS, if it wasn’t a false flag, the story it would be telling is that prices on everything are flattening except for the price of the thing that homebuilders supply. Shouldn’t that be good for them?

I tend to operate with a relatively strong form efficient market hypothesis, with occasional exceptions if you look carefully. On days like today, I don't know what to tell you.

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