September 30, 2023

The Fed will keep rates high thanks to inflation fueled by corporate greed, investors say

(Bloomberg) — Rising corporate profits are a big part of the inflation problem, and keeping interest rates high is the best way to keep them in check, according to Bloomberg’s latest poll of professional and retail investors.

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About 90% of the 288 respondents in a Markets Live Pulse survey said companies on both sides of the Atlantic have raised prices above their own costs since the start of the pandemic in 2020. Nearly four in five said a tight monetary policy is the right way to tackle profit-driven inflation.

One of the worst inflationary surges in decades has sparked a search for explanations – with broken supply chains, governments overspending and rising wages all taking some of the blame. But the increase in company markups is another possible cause that deserves and is now receiving attention.

Read more: Isabella Weber explains the big rethink about the causes of inflation

Margins soared in the early years of the pandemic and defied convention by remaining at historic highs ever since. That raises two important questions: Do larger profits help anchor inflation, and if so, what should be done about it? It’s part of a wider debate about whether different types of price pressures need different tools to address them, rather than the one-size-fits-all response of higher interest rates.

Participants in the MLIV Pulse survey largely believed that monetary tightening by central banks is the right answer to profit-driven price increases. About a quarter disagreed and offered alternative solutions, including the use of corporate tax rates against price gouging and stricter anti-monopoly rules.

Retail has seen the most opportunistic pricing during the pandemic, some 67% of respondents said. The energy industry came a close second with about one-sixth of the vote. These findings may reflect the fact that people are more likely to buy consumer staples than bigger-ticket items, so they’re more likely to notice when prices are rising — an idea known as “collision frequency.”

The unique circumstances of the pandemic – severe supply constraints followed by an unprecedented burst of stimulus-fueled demand – are behind the widening of profit margins, which reached their highest levels in the US in 70 years.

That’s unlikely to last, according to most survey respondents, who expect margins overall to fall to where they were pre-Covid – though the majority at 53% were only a small one.

Standard economic theory states that profit margins are “mean-reverting” – in other words, they tend to return to normal levels. It should work like this: a high-profit industry should attract new entrants, with increasing competition forcing margins to shrink.

But reality has brutally refused to conform. Margins were already elevated before the pandemic, and they are even more so now.

Several theories have tried to explain why this happened. Isabella Weber, an economist at the University of Massachusetts Amherst, argues that much of the recent inflation in the US is “seller inflation,” stemming from the ability of dominant firms to exploit their monopolistic position to raise prices. Weber notes that “bottlenecks can create a temporary monopoly power that can make it safe to raise prices, not only to protect profits but also to increase profits.”

Paul Donovan, chief global economist at UBS AG, calls this “profit-led inflation” — companies using the cover of broad price increases to raise their own prices more than they need to — and more popularly the idea has come to be known as ” greed’.

However it’s labeled, if companies have taken advantage of monopolies to boost their margins, they won’t want to cut them much. Who wants to take themselves a pay cut right after getting a raise?

Margins are starting to fall from their peak as companies rebalance the trade-off between price and volume, but they remain significantly higher than in the pre-Covid years.

This could well continue to favor some stocks. When asked which type of stock benefits most from earnings-led inflation, nearly three-quarters of respondents chose companies with strong pricing power. The logic there is that until a growing backlash against monopolies or oligopolies gets underway, it makes sense to own the companies that can most exploit the inflationary environment.

According to a majority of respondents, “greed” will ultimately not lead to long-term sticky inflation.

Only 10% said it will take more than five years for headline US consumer price inflation to return to a stable average of around 2%. More than half expect inflation to return to a level of 2% within two years – in line with the market view, based on the current two-year break-even rate of around 2.1%.

So what specifically can be done to halt profit-led inflation? The 24% of respondents who don’t believe tighter monetary policy is the answer came up with some thoughtful alternatives.

Among the frequent suggestions were better enforcement of antitrust laws around mergers, along with other efforts to encourage more competition. There was support for higher corporate taxes, possibly including windfall gains in areas where price gouging is seen. “Charge them to oblivion” was a blunt recommendation.

Inflation breeds resentment by exacerbating inequality. Once pandemic savings are depleted, resentment can mushroom, and corporate profit honeymoon is likely to face a much more challenging and regulated future. In that case, a tighter monetary policy may be the least of their worries.

MLIV Pulse is a weekly survey of Bloomberg News readers on the terminal and online conducted by Bloomberg’s Markets Live team, which also runs an MLIV blog on the terminal. Simon White is a macro strategist who writes for the MLIV blog and also has his own MacroScope column, a broad look at key macro and market topics, rising above the short-term noise to get the big picture. Click here to subscribe to the MacroScope column.

Tune in to MLIV at 2:45 p.m. New York time on Wednesday, June 14 for an Instant MLIV Pulse survey at the terminal following the Federal Reserve interest rate decision.

–With help from Sungwoo Park.

(Updates with a video.)

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