CPI Firming, Housing Starts Warming Slightly
The consumer price index (CPI) jumped 0.4% in April, largely due to a surge in prices at the gas pump. Core CPI, which excludes the volatile energy and food components of the index, rose a more modest 0.2%. The overall and core CPI rose 1.1% and 2.1% on a year-over-year basis, respectively. That confirms the trends we have seen since the start of the year: Inflation has firmed but is not flaring. More importantly, deflation is not the risk many once thought it could be.
A growing theme in the CPI data has been the firming of service sector prices over goods prices. Goods prices are more subject to the strength of the dollar and, in the case of vehicles, sweetened incentives, while the service sector is more responsive to domestic demand. The acceleration we have see in prescription drug costs since the start of the year is striking and one of many reasons retirees are so vocal about inflation. Rents also continue to outpace overall inflation, which is crimping the ability of consumers to spend elsewhere.
Separately, housing starts moved close to a 1.2 million-unit annualized rate in April, but remained below year-ago levels. Gains, coming from a low base, were not spectacular. Single-family and multifamily starts both edged higher. The single-family market, in particular, remains constrained relative to demand. Land-use costs have soared and narrowed margins for builders; this has builders concentrating on building fewer, more expensive trade-up homes, instead of building less expensive, entry-level homes where demand has finally returned. The result is likely to show up in even higher prices and more bidding wars for move-in ready, entry-level properties.
The multifamily market is becoming overbuilt; it is moderating from the highs we saw last year. That is welcome news for millennials now graduating from college and hoping to move into cities instead of back home with their parents. However, the slowdown in luxury apartment construction will not come fast enough to bring down rents in some of the most overbuilt markets; Chicago is on the list.
Bottom Line: Incoming data confirm that fears of recession and deflation were overblown earlier this year. As a result, members of the Federal Reserve (including known doves) have voiced concerns that financial markets are underpricing the chance that the Fed raises rates more than once this year. A move at the June or July FOMC meetings can’t be ruled out. Financial markets will not be convinced, however, until Chair Janet Yellen pivots, which is likely to occur sooner rather than later. Look for another big speech from Yellen prior to the Federal Open Market Committee (FOMC) meeting in June.