The One Inflation Number That Actually Matters

The single largest component of the US Consumer Price Index is not groceries or gas bills or college education; it is something called “Owners equivalent rent of residence”. “OER”, as economists like to call it, is 24% of headline CPI and 30% of core inflation (ex food and energy). OER is not rent, per se, but rather a survey-based measure of what homeowners think they could get for their house if they did rent it. “Rent” itself is a further 7.8% of CPI, reflecting survey respondents who do actually rent versus own their own home or apartment.

All in, shelter is 32.8% of CPI, and 41.5% of core inflation. Yet even with that outsized weighting, it gets relatively little attention in terms of assessing its impact on consumer inflation expectations. You hear a lot more about oil prices, food bills, and health care. But even if you combine the weights of all those factors (28.7%), shelter is still more important to the CPI calculation.

To see what the future holds for this key inflation component we went to Zillow, the online real estate platform. Yes, it has other uses besides finding out what your boss, coworkers and friends paid for their houses. Specifically, the company makes available the data for rental listings around the country back to 2011, adjusted for square footage. The information here is not based on leases signed, but what realtors and owners advertise as the proposed rent for a given property.

The best fit we could find for the Zillow rental listing data versus the CPI’s Owners Equivalent Rent was on a one-year lead basis. That makes sense – listings turn into actual rentals, which in turn inform homeowners about market-based rent expectations. All that takes time. Take current inflation for the Zillow rental listing data, wait a year, and that will neatly approximate OER inflation.

The chart below shows this well. Follow the change in Zillow listed rents, and when they fall (as they did in 2011 and 2014), OER shows little incremental inflation a year later. When the advertised rents on Zillow spike (2016), OER increases. The correlation from 2011 – 2017 on this one-year lead basis is 0.68, or an R-squared of 46%. Good enough for government work…

The bad news here is that the Zillow rental listing data shows accelerating inflation over the past year – some of the largest comps since 2011, actually.The most recent year-on-year comparison (January 2018) is +6.1%, or roughly 5x the inflationary trends since 2011 (just 1.2%). The pickup started in April 2017, so it likely hasn’t filtered into the CPI surveys that determine the OER.

Bottom line: while we are somewhat skeptical of the notion that inflation will shoot higher in 2018, this is one legitimate reason to worry. Asking rents have increased markedly. At some point, that will filter through to the CPI measures.

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