Rising rents pressured broader consumer inflation in January, blurring the Federal Reserve's path forward on interest rate hikes, though data lags in the housing sector may be masking an actual drop in prices.
Rent shot up 8% year over year in January, contributing to overall price increases of 6.4%, according to U.S. Bureau of Labor Statistics data. Real-time rent data compiled by Zillow, meanwhile, shows market rate rent prices are down 0.8% since September 2022 and have been falling for four straight months.
Changes in housing prices tend to take about 12 months to be fully reflected in government data, meaning the impact of the Federal Reserve's aggressive rate hikes on rents will likely show up around the second quarter as leases signed when prices were surging begin to expire, said James Knightley, chief international economist with ING.
"We have disinflation before the biggest component really comes to the party," Knightley said. "I remain very optimistic that we can see a big slowdown in U.S. core inflation through the second half of the year."
Big contribution
Rent of shelter accounts for more than 34% of the overall consumer price index. Broader shelter costs — rent, lodging away from home and owners' equivalent of rent — was "by far" the biggest contributor to the monthly increase in the index, accounting for roughly half of the overall increase, according to the Bureau of Labor Statistics.
"Housing inflation continues to be very firm," Aneta Markowska, chief economist with Jefferies, wrote in a Feb. 14 note.
That outsized contribution from housing prices pushed overall annual price changes past economists' expectations for January, according to consensus estimates compiled by Econoday. Excluding shelter from the broader index, prices rose 5.7% year over year in January, a far slower clip than the peak of 10.8% in June 2022.
So-called core inflation, which omits volatile food and energy prices, rose 5.6% year over year in January, down from 6.6% in September 2022.
The fact that rent prices continue to climb while inflation has slowed overall is a sign that the Fed's efforts to chill inflation through tighter monetary policy may be working.
Mixed views
Still, the latest report offered investors a mixed view on the direction of prices and few clues on how the Fed might react, said Jack McIntyre, portfolio manager for Brandywine Global.
"This is going to be one of those reports people are going to slice and dice to justify their views," McIntyre said.
The services component of the consumer price index, which includes shelter, medical care, transportation and insurance, jumped more than 7% from January 2022 to January 2023, its largest annual increase since the early 1980s. Meanwhile, food increased 10.1%, its lowest year-over-year increase since April 2022, and energy increased by 8.7%, well below the 41.6% annual increase the sector saw in June 2022.
"Inflation is slowing, there's no doubt about that," said Callie Cox, a U.S. investment analyst at eToro. "But the composition of inflation is what's most concerning for the Fed."
The cooling in inflation has been driven thus far by goods prices, while services prices remain "fiery hot," Cox said.
This will likely keep the Fed from easing much from its push to hike rates more.
Shortly after the consumer price index data was released Feb. 14, roughly 60% of traders were betting the Fed would hike its benchmark federal funds rate by another 75 basis points by June, according to the CME FedWatch Tool, which measures investor sentiment in the Fed funds futures market. A month ago less than 7% of traders believed the Fed would hike by that much.
"The Fed eagerly welcomes signs of falling inflation but is well aware their job isn't complete," said Oren Klachkin, lead U.S. economist at Oxford Economics. "They won't declare victory until they are absolutely certain inflation has been tamed."