Fed will keep rates high on inflation fueled by corporate greed, investors say

(Bloomberg) – Soaring corporate profits are a big part of the inflation problem, and keeping interest rates high is the best way to rein them in, according to Bloomberg’s latest survey of professional investors and investors. individuals.

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Some 90% of 288 respondents to a Markets Live Pulse survey said companies on both sides of the Atlantic had raised prices beyond their own costs since the pandemic began in 2020. Almost four in five said said tight monetary policy was the right way to fight profit-driven inflation.

One of the worst inflationary spurts in decades has sparked a search for explanations – with broken supply chains, spendthrift governments and rising wages all carrying some of the blame. But soaring corporate profit margins are another potential cause that deserves attention, and is getting it now.

Read more: Isabella Weber explains the big overhaul of the causes of inflation

Margins soared in the early years of the pandemic and defied convention by remaining historically high ever since. This raises two key questions: are higher profits helping to entrench inflation, and if so, what should be done about it? It’s part of a larger debate about whether different kinds of price pressures require different tools to deal with them, instead of the single response of higher interest rates.

Participants in the MLIV Pulse survey widely believed that monetary tightening by central banks is the appropriate response to profit-driven price hikes. About a quarter disagreed, offering alternative solutions including the use of corporate tax rates against price gouging and tougher anti-monopoly rules.

The retail sector has seen the most opportunistic pricing during the pandemic, some 67% of respondents said. The energy industry came in far behind, with about a sixth of the votes. These results may reflect the fact that people buy basic consumer goods more often than more expensive items, so they are more likely to notice when prices rise – an idea known as “collision frequency”. “.

The unique circumstances of the pandemic – severe supply constraints, followed by an unprecedented explosion of demand fueled by the stimulus – are driving widening profit margins to 70-year highs in the USA.

This is unlikely to prove permanent, according to most survey respondents, who expect margins overall to fall back to where they were before Covid – although the majority were only thin, at 53%.

According to standard economic theory, profit margins are “mean-reverting,” that is, they tend to return to normal levels. It’s supposed to work like this: an industry with high profits should attract new entrants, with increased competition forcing margins down.

But reality rudely refused to comply. Margins were already high before the pandemic, and they are even higher now.

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

Paul Donovan, chief global economist at UBS AG, calls it “earnings-driven inflation” – companies using the hedge of widespread price increases to raise their own prices more than they have to – and more colloquially , the idea became known as “Greed”.

Whatever their label, if companies have taken advantage of monopolies to increase their margins, they will be reluctant to reduce them much. Who wants to take a pay cut right after getting a raise?

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

This may well continue to favor certain stocks. When asked which type of stock would benefit the most from earnings-driven inflation, nearly three-quarters of respondents opted for companies with strong pricing power. The logic is that until a growing backlash against monopolies or oligopolies kicks in properly, it makes sense to own the companies that can most exploit the inflationary backdrop.

Ultimately, “greed” is not likely to lead to persistent inflation, according to the majority of survey respondents.

Only 10% said it would take more than five years for the headline rate of consumer price inflation in the United States to return to a stable average around 2%. More than half of them estimate that inflation will return to a level of 2% within two years, which is in line with market opinion, based on the current two-year equilibrium rate of about 2.1%.

So what can be done specifically to stem profit-driven inflation? The 24% of survey respondents who do not believe that tighter monetary policy is the answer offered thoughtful alternatives.

Common suggestions included better enforcement of antitrust laws around mergers, as well as other efforts to further spur competition. There was support for higher corporate taxes, potentially including windfall charges in areas where price gouging is identified. “Tax them to oblivion” was a stark recommendation.

Inflation breeds resentment by exacerbating inequality. Once the pandemic economies are exhausted, this resentment has the potential to multiply, and the corporate honeymoon will likely face a much more difficult and regulated future. In this case, a tightening of monetary policy could 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 maintains 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 view of the most important macro and market topics, rising above the short-term noise to get insight. together. To subscribe to the MacroScope section, click here.

Tune into MLIV at 2:45 p.m. PT on Wednesday, June 14 for an Instant MLIV Pulse survey on the terminal following the Federal Reserve’s rate decision.

–With the help of Sungwoo Park.

(Updates with a video.)

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