Today was a tough day on Wall Street, but the market is basically back to where it was 10 days ago. So instead of addressing the stock sell off today, we’d like to discuss the outlook for inflation.
The latest University of Michigan Survey of Consumers came out today with some worrying data on inflation.
Consumers’ expectations for inflation over the next five years reached the highest level since 1995.
We think the core problem with surveys like this is that consumers have a terrible track record forecasting inflation. The CPI is just too complicated for most people to understand, so by default consumers tend to provide a forecast that is heavily influenced by the most often purchased items like food and fuel.
Without some type of economic shock, we expect inflation to continue to trend lower over the next few years. And yes, the aggressive implementation of high tariffs on most of the world would count as an economic shock.
Over the last few months, the inflation trend has been slightly higher but the marginal component recently has been transportation costs which will most likely subside given oil prices have fallen from $80 to $70 in the last month.
The real driver of core inflation remains housing.
Housing accounts for 43% of the CPI cost basket but is currently responsible for 60% of the inflation rate. We think the CPI inflation rate is being overstated due to the constant lag of real time housing cost data and the CPI estimate.
The Brookings Institute had this to say about this housing inflation lag:
The measure of the rents in the CPI tends to lag well-known indices of market rents like the Zillow Observed Rent Index and the CoreLogic Single Family Rent Index. CPI rent inflation rose only moderately in 2022, while market rents were soaring (see figure). More recently, CPI rent inflation has been much higher than Zillow and CoreLogic rent inflation.
Blackstone has estimated that if the BLS were to swap out their housing cost estimates for real time housing cost inflation data that the stated inflation rate would decline from 3.2% to 2.2%.
While tariffs may complicate the inflation math, we think that the concurrent deportation program may offset much of that impact.
If the administration is able to deport 1-2 million people per year over the next four years, this would alleviate a lot of demand driven inflation in housing, food, etc…
Time will tell of we are right that inflation will continue to moderate, but we think that much of the current worry over increasing inflation may be overdone.
