Why You Don’t Need to Worry About Inflation

Concerns about inflation are flaring up again among investors. Bob Prince, CIO of the well-known hedge fund Bridgewater founded by Ray Dalio (who, like AWARE, started out writing a finance newsletter), said in a recent interview with the Financial Times, “From the beginning of this year until now, neither the Fed nor market interest rates have evolved in the way the Fed described. I think it’s clear the Fed is now off course. The question is how far off course they are,” emphasizing that the probability of the Fed cutting rates this year is slim.

My personal view is different. Inflation has clearly entered a downward trend, and I expect that trend to continue. In this piece, I will lay out the data to support that argument.

The Consumer Price Index (CPI), which the U.S. Department of Labor publishes every month, has been trending downward since January 2023, but its pace of decline has recently slowed. The largest component here is core services, and given that services account for more than 80% of U.S. GDP, it is not something we can ignore.

Long-time subscribers will remember that when AWARE became the first in Korea to call for an impending bout of inflation four years ago, the key factor we highlighted was housing costs. Housing accounts for more than 30% of the CPI basket, so when it runs hot, the CPI tends to come in high as well. If you listen to the reasoning of economists and analysts who now expect inflation to remain elevated, they almost always point to the chronically undersupplied U.S. housing market and the resulting rise in housing costs.

But what matters most in investing is the future, not past data. (Of course, you can use data to judge trends, but this is one reason I’m skeptical about quantitative investing at the individual level.)

Borrowing a few charts from Apricitas Economics, written by Joseph Politano, who mainly covers monetary policy and macroeconomics, I will explain why housing costs are likely to ease inflationary pressure going forward.

The chart above shows statistics on multifamily housing starts and completions in the United States. The yellow line represents starts, and the green line represents completions. The data show the highest level of completions in 50 years, reflecting the rise in single-person households in the U.S. and the chronic undersupply of housing that has persisted since the 2008 financial crisis.

Housing starts have declined compared with early 2022, likely because sharp rate hikes have pushed up financing costs and lowered relative returns, eroding the profitability of residential development projects. (This is why I question whether rate hikes in the 21st century really have much effect in bringing down inflation.)

The result of increased multifamily supply has been a slowdown in the growth rate of new rents since 2023. Rent indices from U.S. real estate proptech firms such as Zillow and the new-lease rent data from Apartment List both confirm that rent growth has clearly decelerated since the second half of 2023.

In the CPI, housing costs are calculated based on the rents current tenants are paying, not new lease contracts. As a result, it takes about 6 to 12 months for lower new-lease rents to be fully reflected. Therefore, I expect the disinflation in new lease rents that began in the second half of 2023, combined with the surge in multifamily supply in 2024, to be fully incorporated into the housing component of the CPI by the second half of 2024.

For this reason, despite the concerns of many leading economists and analysts, the currently elevated housing inflation is very likely a lagging indicator.