OER, CPI and the Fed: A Strange Love Story

What do apartment rents in NYC have to do with Federal Reserve policy, interest rates, and rising bond yields?

According to a recent analysis out of Barclay’s Capital by Dean Maki and Julia Coronado, a whole lot more than you might imagine.

When April CPI was released on May 15th, the surprise was to the softside. U.S. markets rallied, as traders believed rate cuts were coming sooner rather than later. We disagreed with this assessment, noting various Inflation Errors, including the very telling Core/Headline CPI Spread.

Barclay’s looked at the key reason for this CPI surprise — they found it was buried in the way the core CPI gets constructed. The BLS measure of home price inflation is the Owner’s Equivalent Rent (OER); it’s what a homeowner could theoretically rent their house out for. That is the key to the housing portion of the BLS CPI calculation — OER is about 43% of the core CPI measure.

My pal David Kotok (whom I owe 2 bottles of Wine to, having lost a market bet — but thats an entirely sperate post), who is Chairman and Chief Investment Officer of Cumberland Advisors, points to a terrific piece of research from Barclays Capital that "disaggregated the OER and found that the bulk of the OER surprise came
from the New York City metropolitan area. The CPI is broken down into
four regions. Only the Northeast showed a pronounced deceleration in
OER. Within the region, NY jumps out so dramatically that Barclays
argues it accounts for roughly 75% of the total national deceleration
in OER."

Why is this? Given the strength in the Investment Banking, Hedge Fund and Private Equity industries in and around NYC, the local housing market here is doing much better than the national averages. "Barclays surmises that this is tied to the rise in existing home
sales in NY. The region has seen stronger housing sales recovery than
elsewhere in the Northeast or in the national statistics.  Rising home sales suggest a substitution of ownership for
renting. That may be more important than vacancy rates in determining

Thus, Barclays suggests that we not get too excited about a potential Fed easing because of
this surprise in OER.

Kotok makes the following astute observation as to what this may mean: 

"The Fed sees this OER data, too. They incorporate it into their policy decision making.   OER is a very large piece (24%) of the total CPI. It is the key to the housing component which is 43% of the total CPI.  When you remove the food and energy parts and derive the core CPI, the OER component looms even larger at 30% of core CPI. Note that it is a large 14% of the Feds preferred core PCE according to Jim Bianco.

At Cumberland we have been proceeding under the assumption that the national housing slump has not bottomed. We saw the upturn in NY housing sales as an exception to the national trend and due to the bull market in the financial sector. We believe that the weakness in housing keeps the Fed from raising rates even though the inflation numbers are still above the Feds comfort zone.   

This recent analysis by Barclays Capital gives us some pause. Its not enough for us to change strategy now. But we might alter our strategy if we conclude that the nations housing sector deterioration is ending sooner rather than later.

The next CPI release is June 15th and will cover the month of May."


Good stuff, David.  Its more proof that inflation is much higher than reported by BLS.

If I can access the full research document, I will update this later with the link.

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What's been said:

Discussions found on the web:
  1. Winston Munn commented on May 22

    If you want to know what the Fed will do simply keep an eye on the bond markets; the Fed isn’t going to do anything the bond markets won’t let them do.

    Everything else is a dog and pony show to amuse the masses.

  2. patu commented on May 22

    More than $40 billion of takeovers yesterday extended the U.S. stock market’s seven-week rally and helped the Standard & Poor’s 500 Index flirt with a record. Announced mergers and acquisitions this year total $1.04 trillion, 65 percent more than the same time last year.

    “We’re in the middle of the game for M&A,” said David Chalupnik, who helps oversee $63 billion as head of equities at First American Funds in Minneapolis. “That is the driver going forward.”

    When wil the fed pull the punch bowl?

  3. UrbanDigs commented on May 22

    “Rising home sales suggest a substitution of ownership for renting”

    True. But rising rents in NYC (which is the case) suggest an easier BUY vs RENT decision with a bias towards buying. Hence one of the fundamentals that kept NYC real estate so hot.

    Not surprising. NYC historically lags in slowdowns and leads in recoveries. Right now, jobs are plentiful and salary’s are high. Rental vacancy rates are low and rents are high. Do the math.

    I understand that OER / RENTAL PRICES make up a large portion of CPI data which drove me to write my post titled, “Inflation & Condo Conversions: A Good Combo” back on May 15th:


    We must be forward thinking. What is yet to be seen is the number of new dev condo units that are ultimately converted to rentals and/or the number of investor/owned new dev units that are ultimately used for rentals to take advantage of the hot rental market here. I expect more supply to hit the market in the coming year or so, ESPECIALLY if housing eventually cools in Manhattan which during summer months it always does!

    NYC re is seasonal and the hot months are over! Now, expect sales volume to slow, prices to trickle lower, and the rental market to heat up as we get close to the most popular move in date in NYC, Sept 1st! I expect supply to come to market to take advantage ultimately driving down rents at the very end of the year and early 2008 which could have an effect on moderating cpi # down the road. And I’m only talking about Manhattan.

    What about rest of country’s unsold condo inventory that might ultimately hit rental, market? Think of that supply’s effect on OER/RENTAL PRICES and future cpi data.

  4. edhopper commented on May 22

    Just a reminder that NYC is not just Manhattan. Queens has a 13 month housing inventory and the median price is 10x median income. It is still a long way from the bottom of the market.

  5. UrbanDigs commented on May 22

    sorry, i should have clarified. I was discussing Manhattan above. That is the market I work in and know. I am uneducated about Queens, Brooklyn, Bronx & Staten Island. Manhattan is big enough as is to become an expert in, and I’m trying to accomplish that feat now.

  6. Nova Law commented on May 22

    Better yet, if you just count Flint, Michigan, you can say that housing is really, really, really bad.

    Throwing out the housing figures for healthy markets is kind of like saying earnings on the S&P500 are really bad if you exclude the companies that are making money.

  7. mhm commented on May 22

    Nova, you almost got it. Take the DJIA instead of SP500 and you’ll see that the Dow is not a healthy representation of the whole market.

  8. The Big Picture commented on May 22

    OER / CPI and New York Rentals

    Can CPI go lower, regardless of what inflation actually does? That’s the conclusion Barclay’s Capital Research in the research cited earlier. They found Core CPI (also known as Inflation ex-inflation) is being understated for a surprising reason:1. Cor…

  9. David commented on May 22

    I could use a little help. What sort of “pause” is Kotok talking about? Does he no longer credit the strength in the financial sector for the resurgence of Northeast (read: NYC, read: Manhattan) real estate? He now feels more comfortable extrapolating what he thought was an “exception to the national trend” to the fortunes of the housing market nationwide?

  10. The Big Picture commented on May 24

    New Home Sales Up (but beware double digit monthly gains)

    Commerce Department reported that April new-home sales jumped an unexpected 16.2% — the biggest monthly gain in 14 years. The year over year drop in sales change was a drop of 10.6%. By no coincidence, the median home price dropped a 11.1% from the pr…

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