Inflation cools, what does this mean for real estate?

Prices for an array of consumer goods rose less than expected in August in a sign that inflation may be starting to cool, the Labor Department reported Tuesday. The consumer price index increased 5.3% from a year earlier and 0.3% from July. Is inflation really cooling? What does this mean for real estate and in turn stocks? Is it time to open the Champagne and celebrate ?

What was in the recent Consumer price index numbers?

Inflation cooled slightly in August but remained strong, as a surge in Covid-19 infections slowed economic growth and pandemic-related shortages of labor and supplies continued to drive up prices.

The Labor Department said last month’s consumer-price index rose a seasonally adjusted 0.3% in August from July, slower than the 0.5% one-month increase in July, and down markedly from June’s 0.9% pace. Prices eased for autos, with used vehicle prices dropping sharply, and hotel rates and airline fares declined in August from July.

The CPI measures what consumers pay for goods and services, including groceries, clothes, restaurant meals, recreation, and vehicles. On an annual basis, price pressures eased slightly. The department’s consumer-price index rose 5.3% in August from a year earlier, down from the 5.4% pace in June and July, on an unadjusted basis.

Economists surveyed by Dow Jones had been expecting a 5.4% annual rise and 0.4% on the month.

Don’t break out the Champagne just yet. Inflation is not dead!

The 5.3% annual increase keeps inflation at its hottest level in about 13 years, though the August numbers indicate the pace may be abating. Unfortunately, it is not time to rejoice.

CPI is a lagged indicator
- CPI is a backwards looking indicator of what happened 30 days ago, much of the new pricing pressures like wages, shipping increases, etc… have yet to fully filter through
Largest contributor to CPI is housing
- 40% of the CPI index is attributed to housing. Residential houses nationally have increased over 20% in the last year. Furthermore rents have also increased 13% across the country with many areas increasing over 20%. The huge jumps in housing costs have not been captured in the current CPI numbers
Seeing worrying signs in the economy
- Anecdotally it appears everything is increasing in prices throughout the economy from gasoline to eating out, to eating in, appliances, etc… All of these price increases will filter through CPI eventually. For example as the average wage rises for manufacturers eventually the price to consumers will also rise.
International markets seeing huge jumps as well
- Canadian inflation jumps to 4.1%, the highest level in 18 years
- UK inflation jumps to 3.2%, highest in almost 10 years

What does the recent inflation reading mean for interest rates and in turn real estate?

There is only one option for interest rates right now to go which is up. Although inflation numbers came in “better” than expected they are still considerably higher than the federal reserves’ threshold. This means the fed at some point will be forced to taper (buy less mortgage bonds) and eventually increase mortgage rates. The market has not factored in the increases yet, but they are coming. As inflation proves less transitory, the fed’s hand will be forced.

With interest rates poised to rise, this will put a large dent in the current housing market as prices of properties are already expensive and will get relatively more expensive as mortgage payments increase.

Summary

The Federal Reserve and many in our current government are grossly underestimating inflation (both the size of price increases and the impact). I’ve heard the phrase a million times that inflation is transitory. Sure, some supply bottlenecks will ease but is McDonalds going to stop paying workers 15 and hour (up from 12)? Will UPS charge less to deliver a package as their labor costs have increased? It is highly unlikely. Furthermore, a recent study by Adobe found that online prices have increased for the past 15 months following what has been a historical period of declines

The federal reserve and congress continue to pump money into the economy which is exponentially increasing the downside risks to the economy due to inflationary pressures. The longer it takes for the federal reserve to realize that inflation is not transitory the bigger the economic fall will be. Watch for CPI in the next 6 months to remain elevated which will force the fed to react, unfortunately it might be too late to avoid substantial heartburn in the economy.

Resources/Additional Reading

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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine, The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.

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