Inflation is all about the Headlines

By Tim Pierotti

Before becoming a market strategist, I spent much of my career analyzing consumer packaged goods (CPG) companies. One thing that always struck me was the lack of price wars. It’s been a very long time since Coke and Pepsi (or the red system and the blue system to industry insiders) cut prices and margins to gain share. The much more dominant behavior has been either a little bit of annual pricing or a lot of annual pricing. When commodity and transport costs rose, Coke would take more than enough price to offset the costs and so would Pepsi. I’m not accusing these companies of collusion to be clear, but my observation was one of tacit coordination. A new working paper that builds on decades of analysis illustrates that my observation in CPG is systemic across the economy. It also foretells what may be coming: a rapid increase in inflation pressures.

Businesses raise prices when they think their competition will do the same. Headlines of price shocks provide that cover. That is the (oversimplified) conclusion of a new working paper from Isabella Weber and Evan Wasner titled. “Sellers’ Inflation, Profits and Conflict: Why can Large Firms Hike Prices in an Emergency?”

Over the next few months, we are doubtless going to see headlines of companies facing cost pressures due to tariffs or rising labor costs. A headline in the Wall Street Journal this morning (11/21) reads. “An Immigration Crackdown Risks Sapping Farms’ Vital Source of Labor”. The study suggests that headlines like these allow food companies to raise prices with the assurance that they won’t be alone in doing so and thereby risk losing share. The authors write, “When these cost increases are not unique to individual firms but experienced by all competitors, firms can safely increase prices since they have a mutual expectation that all market players will do the same.”

There is a lot of academic and political debate over the impact that tariffs will have on inflation. Those that support tariffs and the President-Elect argue that tariffs will not be passed on to the consumer. They argue that countries that sell goods to the US will weaken their currencies (thereby increasing the relative value of the US Dollar) to partly offset the tax. They also argue that these tariffs are just an opening salvo in a global negotiation to “level the playing field” for global trade. Therefore, the ultimate tariff rates will be much lower than current proposals. Both of these are credible arguments and will, to some extent, offset the full implied impact of the tariffs. The problem, however, is that the administration will not and cannot control corporate pricing behavior. In other words, whether or not you think there will be real NEED for companies to pass through a tariff or not, that is secondary to whether or not they CAN. What the study informs us is that if they can, they will.

Frankly, there is less credible debate on the inflationary impact of deportations. Labor participation is at historical highs and the labor market is secularly tight. Undocumented workers, by various estimates, make up more than 50% of the labor supply in industries from housing construction and maintenance to agriculture and protein processing. Labor prices in these industries are going to go up significantly. Those costs will be unanimously passed on to consumers. We are already seeing companies signal that. Companies loathe to have their income lag their costs so they will want to price ahead of the higher labor costs that they all know is coming.

Fed Chair Powell has insisted that inflation pressures continue to ease and they have maintained their guidance for further rate cuts. The Chairman has insisted that the Fed should be dependent on the actual data and not respond to policy proposals that may be inflationary. The fact that the Ten-year yield has risen meaningfully since the Fed began cutting is the market telling Mr. Powell that he is rapidly falling behind the curve and that policy and the direction of policy is far too complacent.

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