December 6, 2023 4:42 am
December 6, 2023 4:42 am

Why Inflation is Likely to Increase in 2022

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Depending on who you ask, inflation might continue to rise in 2022 or begin to decrease. While US consumer sentiment shows a belief that inflation will decrease, there is evidence in the rental market that inflation might already be understated and could be set to rise through the year.

What is CPI?

The Consumer Price Index (CPI) is constructed by the Bureau of Labor Statistics to measure the change in prices for a variety of goods and services across the United States. When news outlets report on inflation data, they typically refer to the CPI. The other inflation index you’re likely to see is the Personal Consumption Expenditure Price Index (PCE). The PCE is the preferred measure of the Federal Reserve since 2000 but still appears to be less reported.

The CPI accounts for a variety of categories of goods and services including vehicles, food, college tuition, airline fares, healthcare costs, insurance, and more. Each of these categories is then weighted to accurately represent the price levels consumers face. Of special note are food and energy prices. The Bureau of Labor Statistics (BLS) considers food and energy to be more volatile than other categories and will calculate an index with food and energy (headline rate) and an index without these values, the “core” inflation rate.

The housing category of the CPI is nearly a third (30.5%) of the index and is calculated using survey data from renters as well as owners who estimate how much their house might rent for. I found it interesting while researching that the Owner Equivalent Rent (OER) portion, which asks homeowners to estimate how much their primary residence would rent for, is weighted four times as heavily as the rent index, which measures actual rents. While I couldn’t locate a breakdown of the individual OER and Rent Indices to see how they differed, I did locate the housing component of the 2021 Consumer Price Index which shows a price increase of 4.1% from December 2020 to December 2021: an amount smaller than the overall price increase of 7%. With all the headlines I’ve seen about rapidly rising rents I was shocked to see rents, as calculated by the BLS, have lagged price increases in so many other areas of the economy.

Have rents really only increased by 4% this year?

The 4% increase really caught me by surprise as I had read several articles about skyrocketing rent in places like Miami. However, I also realized that my perspective might be a bias to the salience of these flashy and eye-popping headlines. Maybe rent increases really were more muted than I thought?

To test my assumptions, I turned to additional articles that considered rents across the United States and pulled data from Zillow which measured rent changes in 100 different metro areas and found some interesting information

  • Your perspective on rent changes over the last year probably varies greatly depending on where you live. Here in the Bay Area, a renter might have seen 6-8% increases in rents in the last year while in cities like Boston, Phoenix, or Miami a renter might have seen increases of 25%!
  • At a national level, Zumper calculates price increases of 12% and 14% in one bedroom and two-bedroom units. Zillow does not offer the same breakdown between types of rentals but does show an annual increase in observed rents in the nation from $1657 to $1904, an increase of nearly 15%
  • Over the last four years, Zillow data on home sales shows that home prices have increased by 18% more than rents

Why the gap between the BLS and other data?

This gap hasn’t always existed. From 2018 to 2020, the data in Zillow closely matched the CPI

Percent Change of Shelter in CPI Compared to Zill Observed Rent Index (ZORI)

CPI – Shelter3.2%3.2%1.8%4.1%

I don’t expect these measures to be exactly the same due to biases in data collection, but the difference that has emerged in the last year is substantial. For example, if we used the ZORI price change at 14.9% rather than the shelter value of 4.1%, the CPI would be significantly higher. We can calculate how much by multiplying the difference between the price changes, 10.8%, and multiply the difference by the category weighting of 30.5%. Doing so shows us that using the Zillow or Zumper rental data would result in a CPI of 10.3% instead of 7% for 2021.

A couple reasons the difference might exist:

  • Rents and owner equivalent rents are only sampled every six months. It’s possible the shelter value lags market value. While this would be less pronounced when changes are slow, this might be more pronounced when price changes are quicker. If this proves true, then the Zillow’s data might be a leading indicator of future shelter changes in the CPI.
  • Weighting of metro areas might be different
  • Weighting of types of housing unit could vary. For example, there could be variation among the number of bedrooms or whether the dwelling is a single-family home or apartment.
  • Homeowners, who comprise the bulk of the weighting in the CPI, might underestimate the current market rent given the rapid change in price. This seems plausible because homeowners who do not rent are unlikely to be checking prices in the rental market.
  • Rents still have room to grow to keep pace with housing increases

An opportunity to assess your position

Even if the rate of inflation has peaked or is decreasing, we might still see higher official rates of inflation in the CPI. Rents as measured by rental marketplaces show higher inflation than the shelter rates in the CPI. I expect these values to converge somewhat in the future which could mean the official rate ticks higher as the values converge.

Further increase in inflation statistics could increase uncertainty around monetary police and create volatility in the markets. However, if you are already appropriately risk adjusted in your finances then you should continue to feel comfort. This type of volatility is a normal functioning of markets and serves as a good test for your risk appetite. If you feel anxious about your finances, then recognize that you feel anxious. Afterwards, make a rational plan to address your financial risk; you’ll appreciate not panic selling if there is a boom in prices.

At the moment I feel comfortable with my amount available reserves. Even considering a 20% correction in the market, I still have confidence I would not need to touch my investment. This is a good sign that I am taking on a level of risk that I am comfortable with. If graduated in 2012 or later this could be one of the greater periods of uncertainty since graduation. Take advantage and use this as a learning opportunity. For those readers who are young, have a job, and hold a fixed rate mortgage or school loans then you’re also coming out ahead due to inflation.

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