Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / Inside the FOMC's Quiet Housing Market Blind Spot
Transcript
- Lucas: So we got the CPI data for May a few weeks back, and headline inflation ticked up to 334.0 on the index — that's about a 3.4% annualized rate. But what's interesting is what didn't move much in the conversation: shelter costs. Luna: Right, everyone focuses on energy and food — and those matter — but shelter is still the single biggest chunk of core CPI. It's not budging. Lucas: Exactly. Shelter rose 0.4% month over month in May. That's actually a tick lower than the previous months, but it's still running at an annualized pace around 5%. And because shelter is roughly a third of the CPI basket, that alone is keeping core services inflation sticky. Luna: And the Fed's preferred measure — core PCE — came in at 129.6 in April, also up. That's still above the 2% target by a clear margin. So the 'last mile' of inflation really is this housing lag. Lucas: Yeah, and this is where the FOMC's models might have a blind spot. The Fed has been watching 'owners' equivalent rent' — which is basically what homeowners would pay themselves to live in their own homes. It's a survey-based measure, and it tends to lag market rents by 12 to 18 months. Luna: So even if market rents are flattening — and we've seen some softening in places like Austin and Phoenix — the CPI shelter number won't reflect that until mid-2027 maybe. Lucas: That's the worry. The Fed held rates at 3.63% effective in May, and at Kevin Warsh's first meeting last week, they held again. The statement was basically: 'data dependent, no rush.' But I think this housing lag explains a lot of the caution. Luna: And if you look at the ten-year breakeven inflation rate, it's at 2.25% — that's actually down slightly from 2.26%. So the bond market is pricing in a somewhat benign outlook. But that assumes shelter cools. Lucas: Right. If shelter stays hot, the Fed can't declare victory. And the risk is that the longer they stay at restrictive levels, the more pressure builds on other parts of the economy — especially for lower-income renters who are already seeing rent increases outpace wage growth. Luna: So what's the specific data point you're watching that might signal a change? Is it the market rent indexes like Zillow's or Apartment List? Lucas: Yeah, those are leading indicators. The Zillow Observed Rent Index has been growing at about 3% year over year recently, down from double digits in 2021. That's good. But the gap between that and CPI's shelter measure is still wide — maybe 200 basis points. Until that gap narrows, the CPI shelter number will stay elevated. Luna: And the Fed has acknowledged this in speeches — Governor Waller last month mentioned that the housing data is 'noisy' and that they're trying to look through the noise. But it's hard when it's the biggest component. Lucas: I think this is one of those episodes where if you walk through the economy with us and something clicks, it's because we try to cut through the noise. And the reason we can do that without ads is listener support. If today was useful, you can keep this going at buy me a coffee dot com slash fexingo. Luna: Yeah, we really appreciate that. It's what lets us stay independent and dig into these specific angles that might not get airtime elsewhere. Lucas: So getting back to the housing question — let's talk about the supply side. One reason shelter costs are sticky is that housing supply is still constrained. New construction has picked up, but we're well below the levels needed to meet demand that built up during the pandemic. Luna: And the Fed's rate hikes have made mortgage financing more expensive, which actually reduces new construction because developers' capital costs go up. So there's a perverse feedback loop. Lucas: Exactly. The National Association of Home Builders index has been in contraction territory for months. So even though the Fed wants to cool housing demand, they're also suppressing the supply response. That makes the inflation stickier. Luna: So what does this mean for the forward guidance? Warsh didn't give much in his first meeting, but do you think they'll start signaling a cut later this year if shelter softens? Lucas: I think they want to see a few months of sustained improvement in core services ex-housing — that's the supercore measure they focus on. Right now that's still running around 3.5% annualized. If that comes down toward 2.5% and shelter moderates, then maybe a cut in Q4 is on the table. Luna: But the risk is that the geopolitical situation — like the Iran stuff — could push energy prices up again, complicating the picture. Lucas: Right. The headlines this week about Hormuz relief not fully unwinding the economic toll, plus the Bank of England holding at 3.75% — it's a reminder that global factors are still at play. The Fed can't control oil prices. Luna: So bottom line: the housing blind spot means the Fed is likely on hold for longer than the market expects. The ten-year yield at 4.45% suggests the bond market is pricing in higher for longer, but maybe not as high as what the Fed will actually deliver. Lucas: I'd say that's the key takeaway. Until the shelter component in CPI shows a sustained decline — not just a one-month dip — the Fed won't feel comfortable cutting. And that could keep the effective funds rate at 3.63% or thereabouts through the end of the year. Luna: And the next data point to watch? The June CPI release in a few weeks. If shelter stays elevated, this conversation will still be relevant. Lucas: Exactly. We'll keep an eye on it. Thanks for sticking with us on this deep dive. Luna: Yeah, talk to you next time.