Pent-up demand and record monetary and fiscal stimulus drove' inflation's first act. Inflation's second act will revolve around higher house prices, partly driven by record financial wealth and higher wages. Inflation's second act may not run as hot as the first, but it will only be broken with a monetary response.
Statistically, reported inflation has been decelerating, but actual inflation, especially core inflation, has risen again. House price inflation, which is not part of the official price index, has rebounded over the past five months and stands nearly 5% higher than year-ago levels, according to the Cass-Shiller home price index.
The government measure of consumer prices does not include house prices but instead uses an imputed rent measure as a substitute or proxy. But that is not a measure of inflation. For one, it's not an actual price; secondly, no homeowners have ever experienced or paid that inflation. To be accurate and timely, inflation measurement must use transactional prices that people confront in the marketplace. One of the reasons the spike in core inflation in recent years was not as disorderly as previous periods of similar inflation was because two-thirds of households, or homeowners, never felt or experienced it.
House price inflation could run hot for many months. Household's direct holdings of equities relative to real estate stand at close to their highest level recorded during the tech boom. Back then, there was massive portfolio reshuffling away from equities and toward tangible assets, and it should happen again, especially given the sharp drop in borrowing costs in recent months.
The second act of the inflation cycle will also include significant wage increases. In Q4, UPS workers won the most lucrative wage and benefits package in history, lifting wages immediately by roughly 10%. UAW won an 11% wage increase in year one and additional gains over the contract's life. That triggered a flurry of wage increases at non-union companies; for example, Volkswagon raised pay by 11% at its Tennesse plant, Nissan increased wages by 10%, Honda an 11% increase, Toyota by 9%, Tesla hiked wages by 9% at its battery plant, and Hyundai said it would lift wages by 25% over a series of years. Also, Congress recently approved a 5.2% pay increase for federal workers, the most significant annual increase in forty years.
The large and broad wage increases indicate at least a 5% increase in the employment cost index (ECI) in 2024. Since the ECI series started in 1983, there have been only three years in which the annual increase topped 5%, the last being 1990. 2024 should be the fourth; at some point during the year, the Fed will realize a 5% increase in employee costs is inconsistent with a 2% inflation target.
Inflation's second act may not run as hot as the first, but it will be hard to break without a monetary policy response.