Is Zillow Data a Better Inflation Indicator Than CPI?

After a lower-than-expected July inflation print led many investors to rejoice at the prospect of inflation having peaked, the recent August print showed that consumer prices continued to rise year over year – albeit more slowly than prior months. Many investors rely on the CPI to inform their Fed policy expectations, with some hoping the central bank will not need to hike interest rates much further if inflation is already easing, which in turn helped drive a market rally in early August.

By contrast, we have remained a bit more cautious than the market’s consensus inflation expectations. When you disaggregate the Consumer Price Index (“CPI”) into its component parts, it becomes clear that the inflationary pressure we’re seeing today is more broad-based than what we saw early in the pandemic. In fact, whereas 59% of CPI components were running above the Fed’s 2% inflation target in July 2021, 84% are running hot as of July 2022, according to data from the Bureau of Labor Statistics. Meanwhile, there’s been a shift from more transitory, volatile components driving inflation higher to more persistent components coming in above target. For instance, in the early days of the pandemic recovery, used car prices shot through the roof largely because supply chain constraints from Covid lockdowns were leading to low inventory. Today, used car prices have started to moderate and instead, we’re seeing the prices of far more stable components, like shelter, inch up.

Let’s zoom in on shelter. Not only is it a large and influential component of CPI at roughly 33% of the headline index, it’s also a slow-moving one that doesn’t capture home price fluctuation in real-time. The CPI measurement for shelter inflation is actually based on rent levels (i.e., what a homeowner would theoretically pay if they were renting their own dwelling) rather than current home prices. It lags more market-based measure of housing inflation, like data from Zillow, as seen in the chart below.

Shelter CPI is still well below what would be implied by alternative rent measures like Zillow

Shelter CPI is still well below what would be implied by alternative rent measures like Zillow

As of July 1, 2022. Source: Haver Analytics, and the Bureau of Labor Statistics.

Wages, while not a direct input in the CPI calculation, are another important driver of inflation because they impact the ability for companies to pass on higher prices to consumers. Wages have continued to increase year to date, partly to do with the high level of quits rates. Compared to the 12 month moving average of median year over year wage growth from 2000-2020 of 1.9%, year over year quits in 2022 YTD have averaged 2.8% according to the Bureau of Labor Statistics. And there has been a higher correlation between switching jobs and receiving higher wages than for those who stay in the same job – although both groups have seen an increase in wage growth, as the chart below indicates.

Job switchers tend to have higher wage growth

Job switchers tend to have higher wage growth

Source: Atlanta Fed wage tracker as of July 1, 2022. Rolling 12-month average of the median YoY wage growth rate, calculated monthly. The Atlanta Fed defines a "job stayer" as someone whom they observe in the same occupation and industry as a year earlier, and with the same employer in each of the last three months. A "job switcher" includes everyone else (a different occupation or industry or employer).

All of this is to say that we’re not convinced that inflation is going to be as benign as consensus is currently forecasting. Fed Chair Jerome Powell's comments at Jackson Hole in late August bolstered this view - he pointed to the downside surprise in July inflation as a positive development but downplayed the significance of one print. This makes us more cautious on potential downside disappointment should the Fed continue hiking more aggressively than markets are anticipating.

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