Paradoxically, good news is often bad news when looking at inflation. Positive trends like strong economic growth, low unemployment and high consumer confidence can have inflationary impacts. In the current environment, such ‘good news’ could lead the US Federal Reserve (the Fed) to delay any planned – and highly anticipated – rate cuts.
However, recent US inflation data should be seen in a positive light as far as interest rate policy is concerned: price pressures are cooling more than expected; inflationary expectations are declining; household balance sheets are better than they have been for years; and import prices have fallen. Overall, the data support the belief that economic activity, labour market pressures and price levels are cooling. This should create the conditions necessary for the Fed to ease its policy stance later in the year.
There are other encouraging signs pointing to a possible rate cut before year-end. Survey data from the New York Fed showed that US consumers are more optimistic about their current and future financial situation, the stock market and a slowing in inflation. Most importantly, the consumer price index (CPI) was softer than expected in May. Prices held flat for the month for the first time since July 2022. On an annual basis, prices were up 3.3%, which was down from 3.4% in April.
While headline CPI numbers were positive, even more encouraging was the improvement in core CPI, which rose just 0.2% for the month, its lowest rate of increase since October 2023. The annual rate fell to 3.4%, a new three-year low.
Traders indicated this could result in a rate cut as early as September; however, the Fed indicated that it is considering only one rate cut this year – down from the three that were expected last December. Although the Fed remains cautious, the market is more optimistic given that the Producer Price Index, which came out a day after the Fed’s June meeting, showed that wholesale prices fell from April to May. Moreover, the Bureau of Labor Statistics Import and Export Price Index showed that US import prices fell 0.4% in May after rising 0.9% in April.
Housing has been a key factor in slowing the inflation adjustment. Prior to the pandemic, the share of outstanding mortgages with interest rates below 4% was 38%. This figure has since risen to 63%, which has slowed the transmission mechanism of monetary policy and is a significant reason the Fed has kept interest rates higher for longer.
CPI rent and owners’ equivalent rent, which are sourced from the same survey of 7,000 renters each month, have also been factors in the slow downward adjustment of measured CPI. The most recent CPI data release showed both cooled slightly to their lowest levels in two years.
There has been significant demand for rental housing in the US. However, new supply, driven by a 40-year high in new apartment construction, is helping to slow rent inflation, with the largest declines reported in areas with the highest new construction activity. Cooling rent inflation will take time to filter into the CPI data.
Hopefully, we should see these CPI adjustments reflected in an easing in the Personal Consumption Expenditure Price Index, the Fed’s preferred inflation gauge, which will be out at the end of the month.
Housing Affordability Watch
CMI monitors the latest developments and offers insights on solutions to Canada’s housing affordability crisis
Housing policy often falls short in creating effective incentive structures to balance demand and supply. In the latest Housing Affordability Watch, we explore Swedish economist Herman Donner’s insights on housing demand dynamics and discuss how aligning incentives could optimize available housing stock and address supply shortages. Read it here: The Housing Market’s Matching Problem
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