Add SocGen to the list of banks expecting the Fed to go big — very big — at this month’s policy meeting.
On Friday, the bank’s Stephen Gallagher called recent developments on the inflation front “particularly troubling.” “We now expect a 100bps hike,” he wrote, citing increases in “sticky” inflation components, which tend to be correlated to tight labor markets.
The 100bps versus 75bps debate continued into the weekend, as data showed US retail sales for June were resilient, potentially helping the case for an “all-in” move, similar to the Bank of Canada’s Wednesday cannon shot, while a fresh read on consumer inflation expectations suggested the situation may not be as urgent as feared.
Gallagher zoomed in on OER. “The problem is that rents are sticky,” he said. “Headline inflation rates should converge toward core as energy prices retreat [but] rent prices are far less volatile, and historically, a rising unemployment rate is needed to soften rent.”
Earlier this week, Mark Zandi, chief economist at Moody’s Analytics, described the jump in CPI rents as “catch-up with consistent double-digit growth in market rents.” If the latter top out, it’ll presage relief in the CPI gauges eventually, but Zandi (and plenty of others) have suggested the impact of real-world rent growth will continue to manifest in the monthly inflation reports for the foreseeable future.
Supply expectations are all but meaningless for the purposes of assessing the current landscape. As Zandi noted, it’ll take at least a year, and quite possibly two, before rents will come down as a result of any increase in rental supply.
Surging rents are likely to be a source of upward pressure on wages (figure below) as long as labor is scarce and workers have something that looks like bargaining “power” for the first time in decades. I use scare quotes to acknowledge that in America’s hyper-capitalist system, “power” is always a misnomer when it applies to labor as an economic actor.
There’s a maddening chicken-egg problem embedded in this discussion. The Fed needs cooler wage growth in order to bring down inflation which, once the distortions from energy and food fade, may be driven in no small part by shelter costs. But if wage growth cools much further, it’ll fall behind rental inflation, precipitating America’s cost of living crisis and potentially offsetting relief at the gas pump and in the grocery aisles.
It’s too late to prevent shelter inflation from rising because, as noted above, it responds on a lag to a property boom that’s already happened. Engineering the conditions for an eventual moderation entails pushing up mortgage rates, creating an even more onerous conjuncture for everyday people looking to buy a home, while doing little to dissuade investors, who generally pay cash.
Those investors rent the residences they purchase, and if their growing presence in the market keeps property prices elevated, it’ll drive more demand for rentals as affordability problems put homeownership even further out of reach for families. In the final insult, Main Street is expected to help solve this self-referential riddle by losing their jobs. It’s a moving Venn diagram, where all permutations seem to entail Main Street suffering.
Of course, the Fed has no obvious offramp. All roads dead end at cliff’s edge. “[Recession] risks are rising, and Fed aggression adds to the risks [but] with inflation at the highest in 40 years,” policymakers’ options are limited, SocGen’s Gallagher wrote Friday, when odds of a 100bps move oscillated with the ebb and flow of the data.
“While all options were on the table, [Christopher Waller and Jim Bullard] indicated they wanted to see strong numbers between now and July 27 to convince them that 75bps wasn’t the better option at this stage,” ING’s James Knightley remarked, adding that Friday’s “numbers on balance don’t appear to be strong enough to make that case and if they can’t be convinced, it’s unlikely that many others on the FOMC will be.”
Gallagher summed it up best. “The market is moving faster than we can write,” he sighed.
You need to lend Mr. Gallagher your pen Mr. H
I’m on vacation. But I managed to hear a more complete version of Waller’s comments. What caught my half open ear was when he mumbled, almost as an aside, something like”I cannot fathom how we can sink into a recession given all of the job openings.”
I wonder if he ever lifted the hood to check how many of of job advertisements are for part time jobs or are lingering ads which offered salaries which were ridiculous even before the current system-wide jump in wages?
To quote a wonderful eTrade ad, “that was a joke, sir!”
There is one other solution to the rent/buy housing solution. Supply. Not sure we will get it- but something has to give here. I would also guess that demand for housing will weaken a little bit when we get past covid as the craving for space to work at home will moderate (not disappear- but moderate). At the margin I would expect in some markets at least we will see a little bit more capital devoted to producing residential accomodations- even if it boils down to fixing up existing housing stock rather than just building new supply.