Housing's outsized role in the Fed's inflation problem: Morning Brief

Myles Udland
·Head of News
3 min read
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The Federal Reserve's inflation story is all about housing.

Right now, the gap between the Fed's preferred inflation measure and the most popular inflation measure is a full percentage point. But how the two series account for the cost of shelter yields a 1.5 percentage point gap between them — a difference that's offset by other components to its current gap at the bottom of the ledger.

In a new report out Monday, the economics team at Wells Fargo led by Sarah House and Aubrey George explored the gap between two closely watched measures of inflation — core CPI and core PCE.

Last Friday, while markets were closed for Good Friday, new data showed the "core" Personal Consumption Expenditures (PCE) price index — which excludes food and energy — rose 2.8% over the prior year in February.

Earlier in March, the "core" Consumer Price Index (CPI) reading showed prices were up 3.8% over last year in February. The Fed targets 2% inflation and focuses on the core PCE measure.

Wells Fargo notes the spread between these two series typically stands at around 0.3%.

The yawning gap between the two series — one of which makes the Fed appear very far away from its goal and another that puts the central bank on track to meet this goal — is of particular interest to investors looking to nail down the timing of the Fed's move to cut rates.

And the current issue is about weight rather than measurement.

In the CPI, housing costs are about 43% of the core measure. For PCE, housing costs are 17.5% of the core measure. As of February, CPI housing costs were up 5.9% year over year. PCE housing costs were up 5.8% year over year.

As Yahoo Finance's Dani Romero reported last month, the lagging impact of lower market rents and the frequency with which the BLS collects this data have, in part, kept shelter costs elevated and inflation high.

And as we noted last month, Fed Chair Jerome Powell has been clear in asserting the Fed is not "targeting housing price inflation, the cost of housing, or any of those things."

Which means the Fed will just have to wait it out.

On Friday, Powell said the February PCE report was "not as low as most of the good readings we got in the second half of last year, but it's definitely more along the lines of what we want to see."

U.S. Federal Reserve Chair Jerome Powell attends a press conference in Washington, D.C., the United States, on March 20, 2024. The U.S. Federal Reserve on Wednesday left interest rates unchanged at a 22-year high of 5.25 percent to 5.5 percent as recent consumer data indicates continued inflation pressures. (Photo by Liu Jie/Xinhua via Getty Images)
Federal Reserve Chair Jerome Powell attends a press conference in Washington, D.C., on March 20, 2024. (Liu Jie/Xinhua via Getty Images) (Xinhua News Agency via Getty Images)

The team at Wells Fargo said the gap between CPI and PCE "does not appear to be a major source of consternation among Fed officials." Still, the firm notes this spread "could make the FOMC's job of returning PCE inflation to 2% a little harder on the margin."

But as with most things in life, the longer it takes the Fed to reach its inflation goal, the more likely it is a surprise emerges to upset these best-laid plans.

Monday served as another example, as strong manufacturing data showed prices paid — a measure of input inflation for manufacturers — reached nearly a two-year high. In response, the odds for a June rate cut fell back below 50%.

Suggesting maybe the Fed's inflation problem isn't only a housing problem after all.

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