Real Rental Monthly: July 2022

Deceptive y/y comps will "validate" the Fed's inflation complacency for a few months, until comps stop doing the Fed's job for it

From a headline perspective, July 2022 rent internals paint a similar picture to last month’s: it seems like it’s rapidly decelerating on a realized basis and converging to the official status, but the year-over-year comp effect is doing more than 100% of the work.

The impact of rent in understating official CPI has deflated from a peak of 3.8% in 1Q22 to around 2.5% today (OER’s share of CPI ~(30%) multiplied by the spread between Zillow and official rental CPI, which peaked at 12.5 percentage points and has shrunk to 7.2 percentage points today). Effective inflation is still running at around 11 percent, and rent will continue to pull reported CPI upward as official numbers catch up to Zillow numbers.

On a year-over-year basis, inflation comps will get 9 points easier over the next 8 months. If nothing changes in absolute levels (the Fed’s best-case scenario imo), y/y realized rental inflation will be “only” 4% within 8 months, official rental inflation will peak around 8%, and declining realized rent stats will start pulling official CPI down. That will be just in time for Zillow rents to start accelerating again, dragging realized rent CPIs back up.

However, this is all about easing comps doing the Fed’s work for it, and an incompetent financial media parroting the year-over-year figures. We would set up for another ratchet upwards in rental inflation next summer, once again screwing renters.

But that’s optimistic. The YoY comp eased by 170pp because the 2021 comparable month’s comp got 220bp easier, which implies that underlying inflation is still accelerating.

I also like to look at the population-weighted, like-on-like delta in rent today vs. December 2019, even though it’s not nearly as statistically apples-to-apples because the underlying constituents have changed significantly since 12/19.

The “it’s all about the comps” explanation is generally validated when you drill down to individual cities. In the below examples, NYC’s y/y rent inflation decelerated by 150bps off a 350bp tougher comp (underlying inflation +200bps), and Minneapolis decelerated by 100bp off a 100bp easier comp (underlying inflation ~0). SF, the weakest large rental market in the US over the 2020-22 cycle by far, showed 170bps slower inflation off a 260bp tougher comp (underlying inflation +90bps).

Still, as I was scrolling thru the “chartporn” part of my script, some of the red-hot metros seem like they’re falling off a cliff. Like Tampa (orange line below), which crashed out of the top 10 metros in July. Whoa, what’s going on there?

But if you look at the Tampa aggregated index score since 12/19 (right), you see that actually, even in this idiosyncratically very strong edge case, it’s the same pattern as what you see nationally. On an absolute level — even after a full quarter of exploded mortgage rates (which should hit red magnet city markets like Tampa harder than it should hit emigration city markets like SF/NYC), a major stock-market correction, and nonstop bear porn, Tampa’s rental index is actually +3% sequentially over the last 3 months even while its y/y comp has begun to crater. (NYC, the strongest emigration city, by comparison is +450bps over the past 3 months; SF, the weakest, is +230bps).

Tampa’s like-on-like rental index is +50% since 1/1/2020; NYC’s is ~+17%; and SF’s is +5% (!).

This is all a long-winded way of saying that y/y rental comps are now painting a deceptively rosy picture of pending OER deflation over the next 9 months.

The Fed’s failure

As my favorite Fed watcher Joseph Wang aka FedGuy has pointed out, the Fed uses the release of the previous months’ FOMC meeting minutes to clear up what it views as a market misinterpretation of its prior comments, and clear up any ambiguity. Given the market’s fierce rally after hawkish FOMC minutes were released, many expected the Fed’s minutes this past Wednesday to sound quite hawkish and clear up any looming misperceptions.

Instead, the Fed essentially blessed the recent risk rally, and squandered a significant amount of credibility accumulated over its 2022 Volcker pivot. This is playing out very similarly to the early/mid 1970s, when the Fed had clearly been too dovish in hindsight, tried to rebuild its credibility, but always reversed course way too early.

The Fed’s ‘inflation is peaking’ argument has been built on a) a respite in current rental prices driven by a rip higher in mortgage rates, b) a respite in gasoline prices driven by Biden unsustainably blowing out of 160 million barrels of the SPR in the last 12 months, and c) a respite in commodities prices generally, driven by China’s insanely destructive zero-Covid policy and real-estate deleveraging. I would guess that these factors would dwarf the inflationary impact of the Ukraine war at this point; Russian exports of oil and natural gas were only very temporarily interrupted.

All of this would argue for the market-narrative lemmings to get more bullish for a few more months as printed inflation naturally ebbs a bit, before CPI makes a savage return in 2023, and the GOP does their fiscally-conservative-when-out-of-power thing to knock the wind out of federal spending (via presumed control of the House of Representatives).

Y/Y rent inflation chartporn by metro