This Week’s Developments in the US Economy
The Implications of a Potential Fed Pause and a Review of Key Indicators
During the most recent meeting of the Federal Open Market Committee (FOMC) on Tuesday, May 3, Federal Reserve Chair Powell signaled a potential pause in ongoing rate hikes. Mr. Powell acknowledged that the previous ten consecutive interest rate increases, combined with the impact of tightening credit conditions related to the collapse of regional banks in March and April, have brough policy to a sufficiently restrictive position needed to achieve a 2% target, albeit over some time. However, in acknowledging that it will take some time “for the full effects of monetary restraint to be realized, especially on inflation,” it seems clear that understanding whether policy is sufficiently restrictive—or perhaps overly restrictive—cannot be known until policy lags can be measured.
In order to gain a deeper understanding of the changes and momentum of crucial economic indicators that the Fed is likely monitoring for policy effects, we categorized a variety of indicators based on their impact areas (i.e. price, sentiment, and economic momentum) and assessed their annualized pace of change over three-, six- and twelve-month periods. To align with the Fed’s policy targets, for example, we view rates of change below 2% as “positive”, between 2% and the Fed’s year-end projection of 3.5% as “neutral”, and anything above 3.5% as “negative”. The results are illustrative of the potential for a long road ahead given the Fed’s repeated commitments to achieving a 2% target over time.
This Week’s Developments in the Global Economy
Shelter Makes All the Difference: US vs. Eurozone Inflation
Why are Eurozone inflation readings coming in lower than those of the US?
After an unexpectedly warm US CPI print this week, concerns that the decrease in inflation may have stalled are only reinforced by the progress made in the Eurozone. However, a core difference between the two inflation readings is shelter—the US has experienced high rent growth, measured on a lagged basis, and the Eurozone has not seen significant rent growth over the past two decades (see accompanying visual). While both the US and the Eurozone track price growth in their respective economic regions, there are nuances in how they measure inflation that have contributed to the current divergence in inflation figures across the regions. Last year, the Eurozone posted a higher peak than the US in headline inflation, yet current headline inflation in the Eurozone is 110-basis points lower compared to the US.
This does not necessarily imply that the European Central Bank (“ECB”) is winning the war on inflation before the Fed, but instead it speaks to some of those nuances in the US and Eurozone inflation measures. One key difference can be found in each methodology of housing inflation. Not only has the Eurozone seen slower rent growth than the US, but even had the region seen the same rent growth patterns as the US had over the past few years, it would still have a lesser impact on overall inflation in the Eurozone due to a lower index weight and the lack of lagged readings.
Methodological Nuances in the Housing Inflation Component
In March, the headline Harmonized Index of Consumer Prices (“HICP”) in the Eurozone fell from 2.6% to 2.4%, and core inflation decreased from 3.1% to 2.9%. The figures were below consensus, bolstering the case for a rate cut in the Euro Area this summer. In comparison, the figures were also lower than the March US CPI readings, where headline rose from 3.2% to 3.5% and core remained at 3.8%.
Within the current US headline CPI reading, shelter remains one of the largest contributors with 5.7% year-over-year growth and an assigned weight of 36.2%. In contrast, the housing component in the Eurozone holds less than half of that weight at 14.7% and has been disinflationary for the past seven months. The discrepancy in housing inflation numbers across the two regions can, among other methodological variations, partially be attributed to the volatile inflation readings from electricity, gas, and other fuels being grouped with the Eurozone's housing category, which differs from the approach used in the US.
Another notable difference in the shelter inflation measurement across the two regions is the exclusion of owner-occupied housing in the Eurozone. In the US owner-occupied housing is measured as Owners’ Equivalent Rent (“OER”) and carries significant weight within headline CPI, amounting to 26.8%. This exclusion in the Eurozone helps prevent a hypothetical transaction (such as the US OER) from overinflating HICP readings. Further, most Eurozone countries collect rent data monthly, resulting in a shorter time lag between real-time rent growth and rent inflation figures compared to the US, where rent data is collected twice annually for a sampled unit.
Vast Differences in US and Eurozone Rent Growth
According to the ECB, rent growth has contributed an average of only 0.1 percentage points to overall inflation since 1999. This is because rents have seen arguably modest growth in recent years when compared to the US and account for less than 6% of Eurozone HICP. In comparison, year-over-year US rent inflation reached 8.9% last year, while the highest rent inflation figure in Eurozone was less than a third of that at 2.8%.
Unlike in the US, the Eurozone shelter component is not currently driving overall inflation. However, rent inflation in the Eurozone has accelerated over the last few quarters, largely as a consequence of limited housing supply – a trend which might continue considering the -17.7% year-over-year drop in permits issued for residential buildings during 2023 in the Eurozone. While we have observed a softening of rent growth in the US amid an elevated supply environment in 2024, we anticipate a similar pattern of lower supply in the US in the near future.
Market Rates, Catalytic Indicators, and the Week Ahead
Disclosures
© 2024 Bridge Investment Group Holdings LLC. “Bridge Investment Group” and certain logos contained herein are trademarks
owned by Bridge.
The information contained herein is for informational purposes only and is not intended to be relied upon as a forecast, research, investment advice or an investment recommendation. Reliance upon the information in this material is at the sole discretion of the reader. Past performance is not necessarily indicative of future performance or results.
This material has been prepared by the Research Department at Bridge Investment Group Holdings LLC (together with its affiliates, “Bridge”), which is responsible for providing market research and analytics internally to Bridge’s strategies. The Research Department does not issue any independent research, investment advice or investment recommendations to the general public. This material may have been discussed with or reviewed by persons outside of the Research Department.
This material does not constitute an offer to sell any securities or the solicitation of an offer to purchase any securities. This material discusses broad market, industry, or sector trends, or other general economic, market, social, legislative, or political conditions and has not been provided in a fiduciary capacity under ERISA.
Economic and market forecasts or estimated returns presented in this material reflect the Research Department’s judgement as of the date of this material and are subject to change without notice. Although certain information has been obtained from third-party sources and is believed to be reliable, Bridge does not guarantee its accuracy, completeness, or fairness. Bridge has relied upon and assumed without independent verification, the accuracy and completeness of all information available from third-party sources. Some of this information may not be freely available and may require a subscription or a payment. Any forecasts or return expectations are as of the date of material and are estimated and are based on market assumptions. These assumptions are subject to significant revision and may change materially as economic and market conditions change. Bridge has no obligation to provide updates or changes to these forecasts.
This material includes forward-looking statements that involve risk and uncertainty. Readers are cautioned not to place undue reliance on such forward-looking statements. Any reference to indices, benchmarks, or other measure of relative market performance over a specified period of time are provided for context and for your information only.