Near-Record High Profit Margins Indicate the Fed Is Not Winning the Inflation Battle
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The resiliency of the corporate sector has been one of the surprises in 2022. Despite a volatile and uneven economy and a series of interest rate hikes from the Federal Reserve, the corporate sector has maintained record profitability and near-record profit margins. The high-profit margins may be the biggest surprise as it confirms that cost increases have been passed along and not absorbed. That dynamic makes the Fed's job of slowing inflation much more difficult, as it shows an "acceptance" of price increases.
In 2021, real operating profit margins for nonfinancial companies stood at 15.7%, the highest level since the mid-1960s. Surprisingly, companies simultaneously passed along the higher costs of materials, supplies, and labor and lifted margins in the process. And the spread of 275 basis points between final prices and total unit costs was the second widest since the 1960s.
Real operating margins have remained relatively high in the first half of 2022. At 15.5%, real profit margins for nonfinancial companies are still 300 basis points above the levels that were in place before the pandemic.
Q3 data on profit margins are not yet available. But, the price and wage data suggest margins held up if not expanded. To be sure, core consumer prices of 6.4% annualized and core producer finished goods prices of 7% were 100 to 175 basis points over the increase in wages for non-supervisory private workers. Firms' total unit costs were probably lifted somewhat due to rising finance costs.
High-profit margins help to explain why job growth has continued to be so strong this year. Companies added over 1 million workers in the third quarter, about the same number as in the prior quarter. That robust pace of hiring is not something that one would expect if companies, in the aggregate, were experiencing intense downward pressure on margins from rising costs.
Policymakers will never publicly admit this, but the Fed wants an environment where companies cannot pass along cost increases into final prices. That would lead to a decline in margins, a typical outcome during slower growth periods or recessions, eventually forcing cost cuts, including layoffs, less demand, and slower inflation.
Policymakers place a lot of emphasis on inflation expectations, but that is a "soft-data" measure of what people would like to see or expect versus what they are doing or accepting, as is captured in the "hard data" measure of companies' profit margins. Near-record high-profit margins indicate the Fed's job of fighting inflation is far from over, raising the risk that official rates have to go much higher than is shown in policymakers' dot plots or future prices.
Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
Joseph G. Carson
AuthorMore in Author Profile »Joseph G. Carson, Former Director of Global Economic Research, Alliance Bernstein. Joseph G. Carson joined Alliance Bernstein in 2001. He oversaw the Economic Analysis team for Alliance Bernstein Fixed Income and has primary responsibility for the economic and interest-rate analysis of the US. Previously, Carson was chief economist of the Americas for UBS Warburg, where he was primarily responsible for forecasting the US economy and interest rates. From 1996 to 1999, he was chief US economist at Deutsche Bank. While there, Carson was named to the Institutional Investor All-Star Team for Fixed Income and ranked as one of Best Analysts and Economists by The Global Investor Fixed Income Survey. He began his professional career in 1977 as a staff economist for the chief economist’s office in the US Department of Commerce, where he was designated the department’s representative at the Council on Wage and Price Stability during President Carter’s voluntary wage and price guidelines program. In 1979, Carson joined General Motors as an analyst. He held a variety of roles at GM, including chief forecaster for North America and chief analyst in charge of production recommendations for the Truck Group. From 1981 to 1986, Carson served as vice president and senior economist for the Capital Markets Economics Group at Merrill Lynch. In 1986, he joined Chemical Bank; he later became its chief economist. From 1992 to 1996, Carson served as chief economist at Dean Witter, where he sat on the investment-policy and stock-selection committees. He received his BA and MA from Youngstown State University and did his PhD coursework at George Washington University. Honorary Doctorate Degree, Business Administration Youngstown State University 2016. Location: New York.