The San Francisco Fed Anticipates Crumpling Inflation

The San Francisco Fed forecasts where inflation, lead by housing, will likely go next.

Housing is the only category of inflation where you can look back a year and get a sense of what's coming next month.

Housing inflation makes up the largest part of the consumer price index (CPI). It's calculated based on something known as owners' equivalent rent. (Essentially, what the rent value of a home would be).

The problem is that the way the government calculates housing inflation has issues. 

Government data includes rents for all tenants, not just new leases. But landlords can't raise their rent until their lease renews, even if rental rates are soaring. This creates a significant delay in the data, and since rental prices shot up over the last two years, the data is significantly overstating inflation.

The San Francisco Fed published a paper recognizing this using core CPI, which excludes food and energy, for its analysis.

The authors employed asking-rent data to predict future housing inflation. The details may be a bit intricate, but essentially, they created several models and tested them each to determine which was the most accurate.

The final takeaway is astonishing... By mid-2024, housing inflation could turn negative.

Given that housing accounts for over 40% of core CPI, a negative reading will undoubtedly drag down the overall inflation rate. Even if other inflation categories continue to rise, we are likely to reach the Fed's 2% inflation target sometime next year.

Fed Chair Jerome Powell agrees by addressing this issue in his recent speech…

"The market-rent slowdown has only recently begun to show through. The slowing growth in rents for new leases over roughly the past year can be thought of as "in the pipeline" and will affect measured housing-services inflation over the coming year."

While the Fed may still raise interest rates, its most aggressive actions are likely behind us, which means implied volatility will decrease while market growth may be on the horizon.