This is the 'final frontier' in the Fed’s inflation fight, economists say

The Fed may have to hold back on rate cuts this year altogether due to a critical miscalculation.

Until now, the central bank has remained confident that inflation will fall back to its 2% target, paving the way for multiple rate cuts in 2024 and beyond. But it hasn't

The problem? Rent. According to The Wall Street Journal, the Fed has been waiting for rent inflation to cool for a year and a half, but it still hasn’t.

Although rent prices have slowed from their peak in 2023, it’s been at “a much slower pace than pretty much anybody anticipated,” said Jay Parsons, who heads residential strategy at Madera Residential.

Housing “has not behaved the way we thought it would,” said Austan Goolsbee, president of the Chicago Fed. “I still think it will, but if it doesn’t, we’re going to have a hard time” bringing inflation back to its target.

While the Fed appears to have put a cap on wages, it's been powerless in the face of rent prices so far. In fact, average rent prices have outpaced wages by 1.5 times since Covid.

Meanwhile, the average American has to allocate an increasing share of their paycheck toward housing.

Unfortunately, the Fed doesn’t have enough tools to bring inflation down without addressing the underlying issues plaguing the housing market.

All about supply and demand

Surging rent prices are a symptom of a lack of supply in the housing market and a historic migration of housing demand.

For example, when Americans fleed major urban centers during the pandemic, they created demand in areas that historically didn't need that much supply.

This migration pushed up housing prices even in areas that historically weren't on the expensive side.

As Bloomberg reported, the rise of remote work allowed knowledge and tech workers to opt for more affordable regions, raising demand and prices there as well.

“You can even call it a new kind of pandemic gentrification,” wrote professor Richard Florida.

The increase in housing costs since the pandemic has also affected renters, as landlords tend to pass on the higher costs to their tenants.

The question is how long this can go on because Americans are already spending a disproportional share of their paychecks on rent.

According to Harvard University, 40% of households earning between $45,000 and $75,000 per year were “rent burdened.” That means they spend at least 30% of their monthly income on rent.

With more rent-burdened Americans than ever before, demand for affordable housing continues to grow.

According to the National Low Income Housing Coalition (NLIHC), the U.S. has a shortfall of 7.3 million affordable rental homes.

“More and more households that are struggling to pay rent are living just one sort of financial shock away from facing evictions and, in worst cases, homelessness,” said Sarah Saadian, senior vice president of public policy at NLIHC.