"Real" Interest Rates, and the "Real" CPI

Townhall.com ^ | September 26, 2014 | Mike Shedlock

[Kaslin]

With housing prices still rising, albeit more slowly, inquiring minds might be wondering about "Real" interest rates and the "Real" CPI?

CPI Distortions

I believe the CPI is hugely distorted, but not for the same reasons as everyone else. Home prices used to be in the CPI but the BLS now uses OER (Owners' Equivalent Rent). OER is a measure of actual rental prices as well as fiction.

The BLS determines OER from a measure of rental prices and also by asking the question “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”

If you find that preposterous, You are not the only one. Regardless, rental prices are simply not a valid measure of home prices.

OER Weighting in CPI

OER has the single largest weight of any component in the CPI, at 23.957%.



Let's play "What If?" Specifically, "What if the BLS used actual home prices instead of OER in calculating the CPI?"
HPI-CPI

Periodically, Black Knight Financial Services provides the actual data behind their HPI (Home Price Index), a measure of actual prices.

We can use that data to see what the CPI would look like if we put actual home prices in the CPI instead of OER.

I call this the "HPI-CPI".

I passed on an Excel spreadsheet of the Black Knight HPI aggregate housing prices to Doug Short at Advisor Perspectives and we produced the charts below.

Notes

• Click on any chart to see a sharper image
• Data as of June 2014
• Annotations in purple by me

Let's start with a look at the rate of increase in home prices vs. the rate of increases in OER.

Comparative Growth in HPI vs. OER



From 1994 until 1999 there was little difference in the rate of change of rent vs. housing prices. That changed in 2000 with the dot.com crash and accelerated when Greenspan started cutting rates.

The bubble is clearly visible but neither the Greenspan nor the Bernanke Fed spotted it. The Fed was more concerned with rents as a measure of inflation rather than speculative housing prices.

Two Inflation Indexes Year-over-Year



The above chart shows the effect when housing prices replace OER in the CPI. In mid-2004, the CPI was 3.27%, the HPI-CPI was 5.93% and the Fed Funds Rate was a mere 1%. By my preferred measure of price inflation, real interest rates were -4.93%. Speculation in the housing bubble was rampant.

In mid-2008 when everyone was concerned about "inflation" because oil prices had soared over $140, I suggested record low interest rates across the entire yield curve. At that time the CPI was close to 6% but the HPI-CPI was close to 0% (and plunging fast).

As measured by HPI-CPI real interest rates were positive from mid-2006 all the way to 2010, even when the Fed Funds rate crashed to .25%. That shows the power of the housing crash and how badly the Fed misplayed the housing bubble.

Real rates went positive again in mid-2010 until early 2011.

CPI and HPI-CPI Variance From Fed Funds Rate



The above chart shows two measures of "Real" interest rates. The Blue line is the Fed Funds Rate minus the CPI. The Red line is the Fed Funds Rate minus the HPI-CPI.

Both measures show how the Fed has pushed real rates into negative territory.

However, the rate of growth in home prices is slowing. If home prices actually start to decline, which I believe likely, HPI-CPI will show outright deflation.

And even with the Fed Funds rate at 0.25%, real rates will again be positive as measured by HPI-CPI, but perhaps not by the Fed who uses the CPI as its measure of price inflation.

[Blood of Tyrants]

Bacon has reached $8 lb. Beef is 50% higher than last year.

[glorgau]

Home Price Indices are only relevant for those that have their net worth tied up in residential real estate or are looking to buy a house in the near term.

[zeestephen]

True.

But Home Price Indices are “weighted” in the CPI to account for that, are they not?

[logi_cal869]

I am appalled that I had to pay $26+ for 8 pounds of ground beef last week for a recipe. Had I not paid for the bulk packaging, it would have been $40+, noting the price/lb on the other packages.

Fyi, FReepers...there is a practice of incorporating water into meats these days. On chicken packaging you will note “15% added real chicken broth”. I find no such labeling on ground beef, but the amount of water resulting in the pan during cooking amounted to >20% of the net weight (that was Walmart, btw, but NOT Walmart brand).

My recent experience: Kroger/Fred Meyer does not incorporate additional water into their ground beef in bulk packaging. Next time I make the extra trip to the local butcher.

I would not be surprised that steaks might be similarly affected in some chain stores, since they’re doing it with chicken. I’ve noticed the additional water even in the brand names from Costco.

I wish there were somewhere to post this to track the dishonest grocer chains...

[Kaslin]

I don’t know in what grocery store you shop for bacon to have to pay $8.00 per pound, that is awfully high. Here where I am you pay about $5.00 per pound and that is on the high side. You must be shopping at the most expensive store in your town to have to pay that much

[Blood of Tyrants]

My wife was at Kroger. And she didn’t pay for it, she passed.

[Kaslin]

The $26.00 comes to $3.25 per pound, how much percentage was the ground beef fat free? 70%, 80% or 90% percent which I think is the leanest. (It might be 95%) I do remember still though when you could get a pound of ground beef for a quarter and paid a little over $25.00 for four large paper bags of groceries

[Kaslin]

Oh Kroger, that does not surprise me. I avoid Kroger, because they are so high, besides Wal Mart Superstore is closer to me, less than 2 miles

[2ndDivisionVet]

No Aldi’s where you live?

[Blood of Tyrants]

Yep, shop there often.

[Kaslin]

Yes there is, but I don’t care for Aldi. Having to put a quarter in the cart is inconvenient for me as I carry very seldom cash with me

[logi_cal869]

Can’t recall, but it wasn’t ‘7% fat’ (I think it was 80/20). The smaller packages right next to the 5lb logs were 4.99/lb for 80/20. Again...at Walmart.

The water content contrast between the 2 packages at the 2 different stores is what was most astounding, with price/lb nearly the same.

[Kaslin]

The price of $3.25 per pound for 80/20 sounds about right, at least this is what we pay here average I am not sure about the water content though. When I grew up in Germany I don’t remember that water was added to the meat when it was processed.

[logi_cal869]

$3.25/lb or so in 5lb log. $4.99/lb in 1lb pkg.

With the water content, the actual price/lb was $4.07/lb in the 5lb log. Outrageous, if you ask me (yes, I measured it with both my measures and my kitchen scale: About 2 cups of water in the pan after 10 or so minutes of heating, or almost exactly 20% of the net weight). Yes, “water”.