Fed Inflation Goal Is Elusive as U.S. Rents Stabilize: Economy
Federal Reserve efforts to nurture a more robust rate of inflation this year are likely to fall short. The reason: the biggest gains in rents are probably over.
The costs to lease residential real estate, the second-biggest component of the price measure tracked by U.S. central bankers, helped put a floor under inflation over the past two years as most other components decelerated. Now, with builders cranking out a record number of multifamily buildings and the job market still far from tight, the outlook for rents is the bleakest it’s been in four years.
“Because the economy is still not in the strongest position and certainly the labor market is not in the strongest position, landlords really can’t extract much more in the way of rent growth,” said Ryan Severino, a senior economist at real-estate data provider Reis Inc. in New York. Also, rents are already high, which makes more increases difficult, he said.
A quarterly measure of conditions in the market for apartments, which includes elements such as sales volume and the borrowing climate, slumped to 41 in January, the weakest reading since the same month in 2010, according to a survey by the Washington-based National Multifamily Housing Council. Figures lower than 50 indicate the rental market is loosening.
Over the past decade, the index has correctly predicted changes in the housing components of the Commerce Department’s personal consumption expenditures price gauge, the Fed’s favorite, about a year in advance.
The number of residential buildings containing five or more units completed in last year’s fourth quarter reached a 60,793 annualized pace, the most in data going back to 2000, according to CB Richard Ellis Inc., a Los Angeles-based real-estate services company.
Reis projects completions will grow 28 percent in 2014 from last year, with supply exceeding demand for the first time since 2009. Excess supply pushed rent increases down to 3.2 percent in 2013 from 3.9 percent the prior year, and Reis forecasts stabilization at 3.2 percent in 2014 before further slowing to 3 percent in 2015.
Visual Data: Why Has Core Inflation Slowed
That doesn’t bode well for already-low inflation readings. Housing costs make up about 18 percent of the core PCE index that excludes food and energy, the second-largest share behind health care, according to Bloomberg calculations.
Inflation that is too low raises the odds that the world’s largest economy tips into a deflationary spiral of falling prices that hurts borrowers and corporate profits.
The Fed’s preferred inflation gauge, the PCE deflator, climbed 1.2 percent in January from the prior year and has been below the central bank’s 2 percent goal since May 2012.
The core PCE price index advanced 1.09 percent in January from the previous year, the smallest gain since March 2011. Excluding housing, the gain would have been 0.7 percent -- the least since October 2009, according to Bloomberg calculations.
The increase in the housing component has averaged 2.3 percent year-over-year over the past decade, exceeding the 1.7 percent increase for core inflation.
“The housing sector is one of the few areas that’s providing some upward pressures on inflation rates,” said Calvin Schnure, vice president of research at the National Association of Real Estate Investment Trusts and a former Fed economist. “A meaningful acceleration is not likely to happen in 2014.”
Rents probably will cool across the top 100 markets, according to Doug Culkin, president and chief executive officer of the National Apartment Association in Arlington, Virginia. The group sees increases averaging from 2.5 percent to 2.8 percent this year, compared with 2.8 percent in 2013.
Working in favor of bigger increases is pent-up demand as falling unemployment and an improving economy prompt younger Americans to strike out on their own and move out of their parents’ homes, said Jed Kolko, chief economist for Trulia Inc., a San Francisco-based online real estate information service.
“This year, rents are a race between strong supply and strong demand,” Kolko said. “Last year, we saw apartment construction hit a 15-year high, and it typically takes about a year for apartment buildings to come onboard.”
Investors are maintaining restrained price expectations. The five-year breakeven rate, a market gauge of inflation expectations over the next five years based on trading in inflation-linked Treasuries, was at 2 percent yesterday, down from 2.37 percent a year ago.
Housing is among the service components that account for about three-quarters of the core PCE price gauge, giving them more sway compared to goods in determining the direction of inflation. In the past year, core service prices have climbed 1.8 percent compared with an average annual increase of 2.6 percent in data back to 1994, Jim Dolmas, a Dallas Fed economist, wrote last week.
A one percentage-point shortfall in core services inflation has three times the impact on overall prices than a similar miss in core goods, according to Dolmas.
A recent rebound in commodity prices may be what prevents inflation from trekking even lower as rent increases cool, said Michael Montgomery, a U.S. economist at IHS Global Insight in Lexington, Massachusetts. The Thomson Reuters/Jefferies CRB commodity-price index was up 12 percent as of yesterday from Jan. 9, when it reached an 18-month low.
“It ends up with an inflation rate that’s very close to where it was last year” at around 1.2 percent, said Montgomery.
That’s counter to what policy makers project. The central range of forecasts by Fed officials was 1.4 percent to 1.6 percent for this year, according to estimates issued in December.
Lower readings complicate policy for Federal Open Market Committee officials meeting March 18-19.
Central bankers raised concerns about too-low inflation several times throughout their last gathering, with some participants arguing that prices persistently below their target should be considered as detrimental as those that are consistently above.
A still-sluggish job market will probably also curb inflation this year. The unemployment rate rose to 6.7 percent in February from 6.6 percent a month earlier as the number of people joining the workforce swamped the quantity of jobs available.
“The Fed can control a lot of things, but they can’t control the price level as long as everything else is working against it,” said Montgomery.