been about 4-5 months since I last talked about Case-Shiller CPI (CS-CPI).
Case-Shiller CPI is formulated by substituting the Case-Shiller housing index
for Owner's Equivalent Rent (OER) in the CPI for all urban consumers (CPI-U)
index, commonly shortened to CPI.
For a complete description of the reasons and methodology for making this
substitution, please see What's the Real
With year-over-year home prices flattening, the effect of substituting the
Case-Shiller housing index for Owners' Equivalent Rent in CPI calculations
has worn off as the following charts show.
CS-CPI vs. CPI-U
vs. Case-Shiller Housing Index
friend "TC" who produced the charts had this to say...
– January 2010
CS-CPI has risen YOY for the third month in row and measures +2.4% YOY.
Meanwhile the government’s CPI-U also has risen YOY three consecutive
months and measures +2.6% YOY (see first graph). The divergence between the
two is to due to using the Case Shiller 20 city index, rather than the
government’s housing metric of Owners’ Equivalent Rent (OER). The
OER now makes up an amazing 25.2% of CPI, it's heaviest percentage on record.
While the divergence was huge during the housing boom (due to OER
underestimating home prices) and even wider during the housing bust (due to
OER overestimating home prices), it is now relatively small.
January 2010 OER is at +0.4% YOY, while the Case-Shiller 20 city index for
January will likely read -0.3% YOY for only a 70 basis point divergence as
noted in the second chart.
What the charts
shows is how low real interest rates were (and thus the Fed Funds Rate was)
between 2003 and 2006. Greenspan missed the negative real interests that
fueled the housing bubble by focusing on rent as opposed to housing prices.
Likewise, starting in 2007 real interest rates were high, even after Bernanke
cut rates to zero.
With home prices stabilizing and OER falling, CS-CPI and CPI-U are tracking
together. Moreover, real interest rates which had been positive since
mid-2006 (as measured by CS-CPI), are once again negative.
Yet, If housing takes another turn down and OER continues to drop (both of
which I suspect will happen), we can easily see the Fed Funds Rate, CPI-U,
and Case-Shiller CPI converge towards zero, especially if energy prices drop
That deflationary combination is not what Bernanke is hoping for at all.
sign up for a free copy of Sitka’s Monthly Client Newsletter,
please register your email address at the bottom of the Sitka Pacific Commentary Page.
Mish's Global Economic Trend Analysis
on the great inflation/deflation/stagflation debate as well as discussions on
gold, silver, currencies, interest rates, and policy decisions that affect
the global markets.