Main Street Macro: Spring means homebuyers—and a big test of inflation

Like clockwork every year, the end of Super Bowl weekend kicks off the start of the spring homebuying season. Yes, people buy houses all year long. But now is when a surge of new listings hits the market.

This year, the spring housing market will be watched closely by more than just would-be buyers. Investors, economists, and monetary policymakers also are eying listings in both the inventory-starved for-sale market and the rental market. Here are three reasons why.

We spend a lot on housing.

I probably don’t need to tell you this, but housing is a huge part of the consumer budget. So it makes sense that shelter is one of the biggest items in that basket of consumer purchases that economists use to measure inflation.

This bulk of shelter spending is rent, which measures both what actual renters pay every month and serves as a proxy for the rents that owners would pay to live in their primary residence. All told, shelter costs made up more than a third of all consumer spending measured by the Consumer Price Index last year.

Housing is an inflation antagonist.

Last week, inflation came in hotter than expected for the month of January. The increase took markets by surprise and major stock indices dropped on the news.

The CPI leapfrogged economist expectations of a 2.9 percent, year-over-year increase to rise by 3.1 percent.

The good news is that January inflation was lower than December’s 3.4 percent print. The bad news is that closely watched core inflation, which strips out volatile food and energy prices, didn’t budge from the prior month’s 3.9 percent.

Housing costs were heavily to blame. Though housing accounts for about a third of consumer spending, rising shelter prices drove two-thirds of core inflation growth in January.

Housing might be a Fed vulnerability

Since the early days of the pandemic, the housing market has been a big driver of inflation. Unlike with the rest of consumer spending, even Federal Reserve interest rate hikes have been mostly ineffectual in curbing strong homebuyer demand and unwinding rental price increases.

Though rental price growth has slowed significantly over the past two years, rents are still up 29 percent from the start of the pandemic. This year, price growth has slowed to 3.4 percent over a year ago.

The S&P CoreLogic Case-Shiller National Home Price Index shows that homebuyers paid 47 percent more on average at the end of last year compared to before the pandemic. More recently, home prices have been high, but growth has been more moderate. January home prices were up 5.1 percent from the previous year.

My Take

The CPI is an important indicator of inflation, but it’s not the Fed’s favorite measure. The central bank pays more attention to the Personal Consumption Expenditure indicator. PCE and CPI inflation differ by what is measured and how. PCE measures the price of goods and services consumed by households. CPI measures the prices the households pay for goods and services. 

The numerical differences are generally small, and the indices tend to move in the same direction. CPI historically outpaces PCE by a half a percentage point on average.

The real difference for Main Street is that the PCE weighs housing less than the CPI. Hence, big increases in the cost of rental and for-sale housing have less of an effect on the Fed’s preferred inflation indicator, which plays into the central bank’s decisions on monetary policy.

But when it comes to Main Street budgets, the Fed’s preference of one indicator over another doesn’t change new data findings showing that roughly one-third of all US households direct a sizeable 30 percent or more of their budget to rent or mortgage payments.

The simple fact is that people need to live somewhere. Without affordable rental housing and more inventory for sale, the cost of shelter will continue to rise.

That’s why this spring’s housing market is so important. It’s our strongest signal of where consumer inflation is heading.