Housing, Inflation and Why the Fed Should Consider a Pause

Expectations are the FOMC will announce a 50bp rate increase in the federal funds rate tomorrow and increase the "terminal rate" to 5-5.25%.

However, it appears the Fed is missing the recent sharp slowdown in household formation. The surge in household formation during the pandemic was unrelated to monetary policy (it was mostly due to work-from-home and the pickup in divorces). And the recent slowdown in household formation is also unrelated to monetary policy.

This “dramatic shift” in household formation is leading to Rents Falling Faster than "Seasonality Alone". Since rents are falling - and will likely continue to fall - it probably makes sense to look at inflation ex-shelter for monetary policy over the next several months.

This graph shows the year-over-year change in Core CPI ex-Shelter (blue), and the one month change annualized (red). The year-over-year change was at 5.2% in November, down from 5.9% in October. And the annualized one-month change was negative in both October and November! Core CPI ex-shelter fell at 1.5% annual rate in November.

The BLS reported “The index for shelter was by far the largest contributor to the monthly all items increase, more than offsetting decreases in energy indexes.”

CPI Report

From the BLS: Consumer Price Index Summary

The Consumer Price Index for All Urban Consumers (CPI-U) rose 0.1 percent in November on a seasonally adjusted basis, after increasing 0.4 percent in October, the U.S. Bureau of Labor Statistics reported today. … The index for all items less food and energy rose 0.2 percent in November, after rising 0.3 percent in October. …
The all items index increased 7.1 percent for the 12 months ending November; this was the smallest 12-month increase since the period ending December 2021. The all items less food and energy index rose 6.0 percent over the last 12 months.

emphasis added

Both CPI and core CPI were below expectations, and the year-over-year change is declining. Bond yields fell sharply this morning, and the 30-year mortgage rate will likely decline towards 6% today.

My view is inflation will ease quicker than the Fed currently expects and a pause in rate hikes should be considered.