Monday, August 11, 2014

FED: Owner Equivalent Rent at Inflation Rates Not Seen Since 2009

The Federal Reserve Bank of Cleveland writes:
 [T]he overall rate of inflation has risen, owing partly to inflation in Owners’ Equivalent Rent (OER). But many wonder if the current rate of OER inflation, which is now at levels not seen since 2009.
OER is used in the US and in many other countries to estimate inflation in homeowner housing costs. At its core, OER captures the implicit rent that a homeowner would have to pay if he or she were to rent instead of own the same home (or equivalently, the funds that the homeowner is sacrificing by living in the home instead of renting it to someone else). The OER of a particular home is the rent that the home would command under current market conditions, explains the Fed-Cleveland.

Is the climb just a blip? The Cleveland Fed writes:
OER inflation has a considerable “momentum” component; that is, high OER inflation tends to be followed by high OER inflation. It is this momentum that dominates the OER forecasts below:
The "momentum" that the Fed discusses is, as I have been discussing in the EPJ Daily Alert, I believe the result of a decline in the desire to hold cash balances. Indeed, the Fed says it is NOT other factors:
To forecast where OER inflation rates are headed over the next year, we construct a forecasting model that includes these four possible causes: vacancy rates, unemployment rates, house price changes, and interest rates...

Our results are surprising. OER inflation does not appear to be influenced by vacancy rates, unemployment rates, the real interest rate, or our gap measure. Of the variables investigated, only lagged house price appreciation appears to have a statistically significant relationship to OER inflation (previous OER inflation is also statistically significant). In one sense, this is a conundrum, because it suggests that we “cannot explain” OER inflation using the “usual suspects.” High vacancy rates do not appear to slow OER inflation down appreciably; neither do high unemployment rates, low interest rates, or a low price/rent ratio. The only usual suspect which appears to feed into OER inflation is lagged house price appreciation—and even then, it appears to be statistically significant in only about half of the cases investigated. The unemployment rate appeared to be statistically significant at the 10 percent level in two of the Census regions.

OER inflation has a considerable “momentum” component; that is, high OER inflation tends to be followed by high OER inflation. It is this momentum that dominates the OER forecasts..
Thus, the declining desire to hold cash balances appears to be a very strong factor in driving the inflation gains. That said, it is impossible to forecast how this factor will impact rates in the future. If, as I suspect likely, the desire to hold cash balances will continue to shrink. The inflation forecasts made above by the Fed are much too conservative.


1 comment:

  1. And yet, if the FED raised rates how would Congress deal with the problem of servicing the existing debt and continuing budget deficits? Look at a 30 year chart of the ten year bond and explain to me why rates will rise in the near future. After all, you have been calling for rising rates since spring of 2009 and today the ten year is at 2.4%

    $16 trillion debt and 40% of the annual budget is financed. The Ponzi scheme will end someday Robert, but not this year. The Fed will continue its low interest rate policies as long as possible and rates are not going to rise this year and likely not next year.