On FOMC Day, Thinking About Subdued Consumer Inflation And Raging Asset Inflation

As the FOMC winds up its two-day meeting today, one cannot help but think of the Fed put that has led investors to take on risk and go up the risk curve, driving one after another metric into uncharted territory.

On Tuesday, as the FOMC began a two-day meeting, the S&P Case-Shiller Home Price Index published its report for November. Nationally, home prices shot up 9.5 percent year-over-year in that month. This was the fastest y/y pace since February 2014. Prices have been accelerating since bottoming at 3.1 percent in August 2019 and particularly since bottoming at 4.3 percent last June.

The Fed currently buys $120 billion/month in mortgage-backed securities and treasury notes and bonds. Last March, it held $4.2 trillion in assets, versus $7.4 trillion now. The 30-year fixed mortgage rate has been under three percent for six months now.

Home sales have been very strong, and inventory is tight. The result is persistently rising prices. The Fed probably deserves kudos for strong housing numbers as its purchases of the aforementioned bonds has put a lid on rates.

But there is another aspect to this as well. This is also inflationary. Chart 1 plots the difference between the y/y change in home prices and core PCE inflation, which is the Fed’s favorite measure of consumer inflation.

In the 12 months to November, core PCE (personal consumption expenditures) rose 1.38 percent. The last time it grew with a two handle was in December 2018. As far as this metric goes, there is no inflation in the system. Concurrently, home-price appreciation has exceeded consumer inflation since August 2012 (Chart 1). If prices are rising at eight or nine percent a year, a homebuyer may have to reduce expenses elsewhere, because his income will not be keeping up with this, not particularly if wages are indexed to consumer inflation.

So, it is an important variable. But the Fed in all probability is not looking at the issue this way, rather from the viewpoint of the wealth effect.

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