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What Fed Chair Powell said about the relationship between profit margins and inflation 💸
Inflation has yet to cool as profit margins hold up 🤨
As we discussed in the March 9 TKer, profit margins are becoming a key controversial issue in the inflation discourse.
The narrative goes like this: Supply chain disruptions related to the pandemic led to shortages and forced the costs of goods to rise. Corporations passed these higher costs to their customers, which is what’s been driving inflation across the economy.
However, the data shows that amid these price hikes, corporate profit margins actually expanded. And even as supply chains have normalized and costs have come down, corporations haven’t made a commensurate move lower on their prices. This is all confirmed by more recent data showing profit margins remain high — and in some cases are expanding.
During the Federal Reserve’s post-monetary policy meeting press conference on Wednesday, the AP’s Chris Rugaber asked Fed Chair Jerome Powell if he saw higher profit margins as a driver of higher prices.
Powell essentially said yes. Here’s his response:
So higher profits and higher margins are what happens when you have an imbalance between supply and demand — too much demand, not enough supply. And we've been in a situation in many parts of the economy where supply has been fixed or not flexible enough. And so, you know, the way the market clears is through higher prices. I think as goods pipelines have gotten, you know, back to normal — so that we don't have a long waits and shortages and that kind of thing — I think you will see inflation come down and you'll see corporate margins coming down as a result of a return of full competition where there's enough supply to meet demand. And then it's — then you're really back to full competition. That would be the dynamic I would expect.
Maybe there’s a bit of a lag between the correction in the supply chain and the prices consumers and businesses pay. We’ll see.
Regardless, recent news coverage suggests this dynamic between inflation and profit margins may continue to intensify.
More and more news coverage of the profit margin story 📰
Believe it or not, profit margins may actually be expanding again.
The Wall Street Journal published a feature Thursday noting: “More than halfway through the first-quarter earnings season, the net profit margin of companies in the S&P 500 has ticked up to 11.5% from 11.3% in the fourth quarter, based on actual results and estimates for companies that haven’t yet reported.“
This follows a big feature the Journal published on Tuesday (via Notes) titled, “Why Is Inflation So Sticky? It Could Be Corporate Profits.“ The headline speaks for itself.
For more on improvements in the supply chain, read: We can stop calling it a supply chain crisis ⛓.
To be clear, profit margins aren’t improving from depressed levels. Rather, they’re expanding from historically high levels.
The S&P 500’s operating profit margin “is on track to bounce back to 12.0% in Q1, which while well below the record highs of 2021 would be at the top end of its pre-pandemic range,” Deutsche Bank’s Binky Chadha wrote last Friday. “The margin for the median company is also set to bounce off its Q4 low.“
There are several reasons margins have held up, including mass layoffs that have made for leaner operations for some companies.
But the more controversial and more inflationary of these reasons is companies jacking up prices for customers that are willing to pay up.
Consider PepsiCo’s Q1 financial results. The snack and beverage behemoth reported a 14% increase in organic revenue. But growth was driven entirely by higher prices, which more than offset the decline in sales volumes.
For the full year, management expects organic revenue to grow 8% as adjusted earnings per share rise 9%. In other words, they are expecting profits to outpace sales.
For more on price hikes in consumer goods, read: Cottage cheese and how to take the fight against inflation into your own hands ✊
A controversial issue with many names 🤬
In a November op-ed for the Financial Times, UBS economist Paul Donovan called out this “profit-led inflation.” U.S. Sen. Sherrod Brown, an Ohio Democrat, later cited the piece during Powell’s semiannual appearance before Congress.
In February, UMass Amherst economics professor Isabella Weber published a paper on “sellers’ inflation,” arguing among other things that “firms tend to not lower prices to prevent price wars and raise prices to protect profit margins.“
Later in March, Albert Edwards of Societe Generale framed it far more aggressively, calling it “greedflation.”
Everyone offers unique nuance in their reporting and research. But the overarching theme is the same.
Even as they draw more attention, big corporations are unlikely to voluntarily roll over on prices, as they’ve proven to be quite ruthless in their pursuit of profit growth. This will especially be the case for publicly traded companies, as profit growth is the most important long-term driver of stock prices.
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