Despite rising oil prices driving headline inflation higher, housing inflation continues to head lower.
There has been plenty of talk about inflation over the last few years. That conversation has had its moments of being hot or cold, but recently it’s been hot as oil prices rose significantly following the start of the Iranian conflict. Headline inflation has ticked up; however, the housing market has cooled off. According to Zillow’s Observed Rent Index (ZORI), YoY rental rate growth has been less than 2% for four consecutive months. Over the last twenty years, there have been only four other periods when YoY % in ZORI was less than 2% for four consecutive months: 2020, 2014-2015, and 2009-2012. The 2020 covid environment was due to the exogenous circumstances of the period rather than underlying weakness in the housing market like the other two periods. Nonetheless, this is the weakest housing market we’ve seen in terms of rental rate growth in over a decade and is not supportive of higher inflation once/if oil prices begin to come down.
The price action in homebuilder stocks suggests the market has been anticipating shrinking margins for some time. The State Street SPDR S&P Homebuilders ETF (XHB) has not made a new all-time high since November 2024 and underperformed the S&P 500 by over 40% since then. XHB has rallied back to its negative trend line, but the technical picture is overwhelmingly weak. With both builder price action and rental rate growth in a poor state, the backdrop for the housing market is not conducive to higher inflation from that section of the market.
The immediate takeaway from this information is that homebuilders should generally be avoided for now. If we look at a comparison between YoY % changes in the Zillow Observed Rent Index and Headline CPI they are usually correlated. Headline CPI is a bit more volatile as things like food and energy, but historically tracks well with rental rate growth at least directionally. The divergence between the two recently is clear on the chart below as rental rate growth has headed lower for over a year now. Headline CPI was tracking along with rental rate growth for most of the last year until the recent oil price shock. If or when we get a resolution of that conflict, it can be expected that headline CPI will begin to track back down to where rental rate growth has been heading. This would open up interesting opportunities on the fixed income side which has been an out of favor asset class for some time. While it will not compete with equities until there’s some relative strength, there could be more viable use cases for fixed income in the near future.
