US Fed needs to raise interest rates just enough to maintain credibility but not enough to throw the economy into recession
https://asiatimes.com-by David P Goldman
Inflation is squeezing US corporate margins and hitting stock prices. Image: Twitter
NEW YORK – Labor and raw materials costs are squeezing corporate profit margins in the United States, as prices received lag input costs.
Major US corporations raised prices fast enough during the first three quarters of 2021 to stay in front of the inflation wave, but rising costs, especially for labor, are now overtaking them.
This leaves the Federal Reserve in a quandary. Supply constraints are the main culprit in the present inflation wave, starting with labor. Two million Americans haven’t returned to the labor force after the Covid recession of 2020.
As of the third quarter last year, unit labor costs had risen 6.3% year-on-year, the biggest increase since the early 1980s. Supply constraints for inputs ranging from petroleum to computer chips are eating into profits.
Monetary policy can’t fix supply chain problems. A modest increase in interest rates will have no impact on inflation, and a severe increase would throw the economy into recession. That leaves the Fed with one choice: Raise interest rates just enough to maintain credibility, but not enough to unsettle the economy.
Investors late last week concluded that the Fed would proceed with caution. Inflation-indexed Treasury yields fell and the Nasdaq 100 Index snapped back.
But the underlying inflation problem remains, and the available data indicate that it is eating away at profitability.
The Philadelphia Federal Reserve’s monthly survey of non-manufacturing business (88% of the US economy) is an early-warning indicator of the direction of business conditions. In January, 63% of respondents reported higher input prices, but only 37% reported higher prices received.
The scissors that have opened between prices paid and prices received indicates pressure on earnings.
Some Wall Street strategists warn that S&P 500 operating margins may have shrunk due to higher costs. Equity investors are watching corporate announcements carefully for indications of fragility in operating margins.
Overall business activity decelerated sharply, the Philadelphia Fed also reported, with firms reporting a net decline in business during January.
It’s hard to tell whether the January air pocket reflects the spike in Covid-19 infections from the Omicron strain, or consumer resistance to higher prices. Retail sales unexpectedly fell in November and December as consumers balked at price mark-ups.
At some point, US corporations will run out of wiggle room to raise prices and profitability will fall. Operating margins for most sectors fell slightly during the fourth quarter, according to S&P estimates.
Notable exceptions are utilities and energy producers. Tech margins held up, which is not surprising, because the large-cap tech companies consume little by way of labor and raw materials.
But the trend is worrying and continued inflation will squeeze margins further, leaving equity investors with few sectors in which to hide.