There is no inflation in the United States!

Markets remain riveted on the Fed, but long-awaited interest rate cuts are playing tricks on the public.

Last December, the US central bank promised three cuts in key interest rates in 2024. No way. Time passes and the financial markets still see nothing coming. The Fed is dragging its feet in implementing its easing policy and the risk of tipping the US economy into recession has seriously increased.

The accepted expression to describe the central bank’s delay is to place it “behind the curve” (behind the curve). But be careful, this expression is ambiguous and can be used both to illustrate the delay that the central bank is taking in tightening its monetary policy and for its easing. At the beginning of 2022, when American inflation was galloping at more than 8%, James Bullard, the President of the St. Louis Fed, complained that the Fed was “behind the curve” in that it was not raising interest rates quickly enough to crush the rise in prices. Mr. Bullard’s complaints would be heard by his colleagues: in twelve months, the Fed would drastically increase the key rate from 0.08% to 4.33%. In this case, it would be more appropriate to speak of an American central bank that placed itself “ahead of the curve”, in that it increased key rates more quickly than inflation.

In short, let’s say more simply that today the Fed is behind schedule on the interest rate cuts it had promised. The American central bank justifies its wait-and-see attitude by arguing that the “last mile” – the one that would allow inflation already sharply reduced to around 3% to reach its 2% target – is the hardest to achieve.

In statistics, as in life, the devil is often in the details: a detailed analysis of inflation in the United States shows that it is fundamentally exaggerated compared to reality.

The graph is crystal clear: we have an inflation rate in the United States today of 3.3%, as shown by the burgundy curve. The orange curve shows us what the inflation rate would be if we ignore the cost of real estate. When we subtract it from the consumer price index, inflation falls to 1.7%. Better still, this corrected inflation is sailing below the 2% target set by the Fed for more than a year.

Without real estate, inflation in the United States is no more

Let us now see what reasons might justify focusing on an inflation rate corrected for the cost of real estate.

The index that everyone looks at to measure inflation in the United States is the consumer price index (CPI). The Fed, for its part, favors a broader index, linked to consumer spending (the “Personal consumption index” or PCE). Both are strongly influenced by the cost of housing. This weighs 34% in the CPI and 15% in its PCE version.

Two-thirds of American households own their own property, while the remaining third are renters. Both are affected by the cost of housing.

Let’s start with renters. Rents are determined by supply and demand in the housing market. Nationally, there is a housing shortage, although there are large regional differences. In addition to possible imbalances between supply and demand in the housing market, rents are also set by inflation and interest rates. When the Fed raises the policy interest rate, mortgage rates follow suit, discouraging households from buying homes and encouraging them to rent. Both the increased demand for rentals and the increased cost of borrowing will lead homeowners who rent out their homes to raise rents. Indexing to inflation does the same thing.

There is therefore a perverse effect in any tightening of monetary policy: that of increasing inflationary pressures through the cost of real estate. It is not for nothing that the United Kingdom publishes a consumer price index stripped of mortgage rates, the CPIX.

But let’s return to the consumer price index in the United States. The share of rents represents 8% of the index, or one third of the aforementioned 34%. Inflationary pressure from rising rents could actually be the consequence – at least partially – of a more restrictive monetary policy aimed at eradicating inflation!

Now let’s look at the cost of real estate for owners. The calculation method used here is the “owner’s equivalent rent” (Owner equivalent rent or OER). What is it? It is an estimate of the opportunity cost to a homeowner of living in their own home. Government statistics collect information on rents for similar homes to estimate what homeowners would pay if they were renters. If home prices rise, homeowners benefit from a wealth effect that boosts their consumer spending. But in the OER calculation, the exact opposite is happening: homeowners are being charged a cost of housing that reduces their consumer spending, when this is not the case, since this is a purely hypothetical calculation.

In summary: a good third of inflation in the United States is linked to real estate. With an 8% share of the consumer price index, we have rents that would have to be adjusted for the aforementioned perverse effect that any increase in key rates by the Fed has. And we still have a considerable weight of 24% in the CPI that reflects a cost of real estate that does not exist for owners! Worse, this calculation should cut consumer spending by owners, when in reality, the opposite is happening!

Conclusion: the Fed would be well advised to lower rates quickly: a good part of official inflation is purely hypothetical. The threat of recession linked to the failures of the American central bank is becoming, for its part, very real!

This is evidenced by the latest employment figures in the United States, published last Friday. The unemployment rate is increasing. The gap with the minimum recorded over a historical period now exceeds the 0.5% mark indicated in orange. Since 1965, each time we have experienced this situation, a recession has not been long in coming.

US unemployment rate signals danger of recession




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