Home Prices, Equivalent Rents, CPI, TIPS, and Fed Policy

I have an angle to discuss with anyone following CPI (inflation) and Fed policy.   This is my latest effort to look for reasons for potential longs to be interested in the inversion that’s taken place in the CME  Case Shiller home price futures.

The table below draws data related to home prices and CPI from a number of sources and is being used to pose the question: what happens to inflation (or inflation expectations), if year-on-year CME Case Shiller home price futures suggest that home price gains for 2019 and 2020 might be negative?  (…and from my perspective, might this merit a trade?).

The historical data (2014-2018) shows CPI, YOY the Case Shiller 10-city home price index (and YOY % changes), the Fed (St. Louis) calculation of equivalent rents, and the premium of equivalent rents over CPI.  I’d note that the YOY gains in the Case Shiller index have been about 50% greater than equivalent rents, and that equivalent rents have been higher than overall CPI each year.  (Note that owner’s equivalent rents makes up about 25% of CPI)

However, the CME futures for Feb 2020 (so referencing year-end 2019) and for Nov 2020 vs. Nov 2019 (so a possible proxy for 2020) YOY clearing levels, are both negative.  What impact might actual negative Case Shiller YOY values have on the calculation of owner’s equivalent rent?  I would imagine that it might drag down that portion of CPI.    If so, then why are inflation expectations relatively unchanged from 2017-2018?

I might imagine that such inflation expectations are priced into shorter TIPS (Treasury Inflation Protection Securities).  If so, there might be an opportunity for someone participating in both markets to short TIPs and buy 2-3 year forward HCI futures.  There has been little traded, but I’d be open to trying to facilitate a small trade by selling 10-20 lots.

Meanwhile, if the contracts are correct (despite thinness of trading) how might the Fed proceed?    If lower home price gains reduce inflation, it might appear to give the Fed license to continue unwinding the balance sheet, without immediate fear of inflation rising.

Please feel free to contact me (johnhdolan@homepricefutures.com) if you’d like to discuss the above blog, have any questions on it, or have any trading ideas.



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