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.
To Powell’s credit, inflation has indeed eased from its hottest levels a year ago. But it has not fully normalized like many of the critical links in the supply chain.
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.
Again, all of this is happening as supply chains continue to loosen. Just this week, the April ISM Manufacturing survey signaled further improvement in supplier delivery times (via @RenMacLLC).
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.
Chipotle Mexican Grill and Starbucks were among other companies reporting greater profitability thanks in part to higher pricing.
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 🤬
More and more prominent folks have brought attention to this issue since we began pondering on the matter in October.
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.“
In a March episode of the Odd Lots podcast, Bloomberg’s Tracy Alloway and Joe Weisenthal labeled it “excuseflation” — because businesses had been using cost inflation as an excuse to boost prices.
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.
Nevertheless, expect profit margins to increasingly become a key controversial issue in the inflation discourse.
Related from TKer:
The indisputably good force behind the supply chain nightmare 🚛
9 stock market charts to consider as earnings season kicks off 📊
Are 'gravity-defying' profit margins finally coming to an end? 💸
Profit margins are becoming a key controversial issue in the inflation discourse 🤬
Cottage cheese and how to take the fight against inflation into your own hands ✊
Just to sort this out in my head-greedflation is causing the Fed to raise rates to combat inflation, and until enough people get laid off that they can't afford these and other company's goods and they will all then have to lower prices, rates will continue to rise or stay high. At the same time, these rates are causing a credit crunch and causing banks and certain businesses to fail, largely because other businesses are gouging the consumer and tightening lending. So, basically large companies with low debt are charging higher prices and killing mostly smaller companies who need liquidity (and are calso trying to charge higher prices) and causing layoffs which will put us in a recession, bring inflation near 2%, and eventually even hurt their own business. Then rates go down and lending starts and we repeat. It's like a circular firing squad and as clear as mud.
Great article once again Sam. But if consumers are willing to pay higher prices, are prices really too high? Yes, everybody needs to eat, but do we really need Pepsi, Chipotle, and Starbucks? There are cheaper alternatives. Even Warren Buffett doesn't buy expensive things if they don't provide good value.