US Macro: Housing to remain strong, but not necessarily inflationary –

We received a host of US housing indicators over the past week or so, the bulk of which suggested continued strength in both home sales and prices, as well as housing investment. According to the S&P Core Logic measure, US house prices continue to rise at over 10% yoy.

While there is some evidence of strength in housing being driven by an exodus from big cities to the suburbs (and beyond), the growth in the top 20 US cities in the S&P index is only a little below the national figure (10.1% vs 10.4%).

Some of the strength in housing investment reflects a degree of pent-up demand – the current level of building permits is the highest since 2006, but this is merely making up for a shortfall in the first half of 2020, when activity was depressed by lockdowns. At the same time, housebuilding continues to lag household formation, suggesting considerable further room for both house price inflation and in turn housing investment over the coming quarters.

Wage growth appears to be a bigger driver of housing inflation –

While all of this bodes well for economic growth, the key question for monetary policy is, to what extent the supply/demand imbalance of housing, and the accompanying rapid house price appreciation might become inflationary?

Indeed, in the US, the CPI is notable for having a significant weighting for housing costs – making up 42% of the core CPI basket (although it is a significantly smaller part of the Fed’s key focus – core PCE – at 18%). However, housing inflation is measured not by house prices, but housing rents – both actual rents, but also so-called ‘imputed’ rents (this is measured by asking homeowners what they would be able to rent their home out for).

And rental inflation does not necessarily follow house price inflation; indeed, the two often behave very differently. We find that housing rents show a much stronger and more stable relationship with wage growth than to the demand/supply balance.

This suggests that even with relatively tight supply, rental inflation – which has fallen significantly since the onset of the pandemic, and has yet to meaningfully recover – might not sustainably pick up until labour market slack is exhausted and wage growth accelerates back to the levels seen before the pandemic.

Subdued wage growth to keep rental inflation in check –

While average hourly earnings have grown relatively strongly over the past year, this is due to a compositional effect of lower wage workers being furloughed (in the chart above, we show aggregate compensation growth to avoid this compositional effect, but this is released with a much longer lag).

As such, we will not get a clear read on wage growth until the economy has fully reopened. However, with significant slack likely remaining in the labour market for at least the next two years, wage growth will likely take similarly long to get back to pre-pandemic levels. This should in turn keep housing inflation in check.