The Fed’s victory lap | USAEMALL.com

Good morning. Last week was quiet, and this week everyone, except Unhedged and assorted other underlings, is on vacation. Does that mean nothing will happen, or that if something does happen, there will be no grown ups around to quell the panic? Email your predictions for the slowest (or possibly not) week of the year: robert.armstrong@ft.com and aiden.reiter@ft.com.

The Fed

During his speech on Friday — not quite an outright victory lap, but close — Jay Powell gave a lot of credit to anchored inflation expectations:

An important takeaway from recent experience is that anchored inflation expectations, reinforced by vigorous central bank actions, can facilitate disinflation without the need for slack [in the economy].

Powell is right. With retrospect, it looks like what has mattered most with falling inflation was supply shocks abating and confidence that the Fed will do what it takes. The particular level of the federal funds rate, and expectations of where it will be in the near term, look beside the point.

What the market thinks the Fed would need to do to keep inflation under control has vacillated wildly over the past year. The Fed’s expectations have followed the same general pattern, but in a tighter range. Here is the futures market’s expectations for what the federal funds rate will be in December 2024, as well as the Fed’s projections from its quarterly summary of economic projections (the last SEP was released in early June):

One cannot help but notice the pattern of overreaction and correction on the market side. It’s like a car on an icy road. There is a whole sub-industry — Unhedged is part of it — that spends its time arguing about why the Fed is too loose or too tight. But in retrospect we probably overstate the importance of the current and expected level of rates. What matters is keeping expectations anchored on the one hand, and avoiding an unnecessary recession on the other. So far, the Fed has stayed within these lines. The rest is details.

Chair Powell said it well:

The limits of our knowledge — so clearly evident during the pandemic — demand humility and a questioning spirit focused on learning lessons from the past and applying them flexibly to our current challenges.

This has been a weird cycle. No one has looked smart at every stage of it, and anyone who says they did is selling you something.

(Reiter and Armstrong)

Greedflation part 1: retailers

Greedflation — to the degree Unhedged understands the term at all — is an increase in prices caused by higher corporate profits, as opposed to an increase in prices caused by high input costs which corporations pass on to customers, leaving profits stable. In the pandemic inflationary episode, the charge against corporations was that they used price shocks as a co-ordination mechanism. Under the cover of a general atmosphere of higher prices, corporations pushed prices higher than was required by more expensive commodities, labour, and so on. This padded profits at consumers’ expense.

This notion has found its way into presidential politics, in the form of the Harris campaign’s reference to “price gouging” in groceries in particular. 

Whether greedflation is something we should worry about and, if it is, what we might do about it are important questions. But there are questions we should be asking first: did it happen at all? In what industries? Where in the value chain?

Following the vice-president, let’s start with groceries — grocery retailers, in particular. Certainly, as the chart below shows, groceries saw a dramatic price increase in 2021 and 2022, and grocery prices are now a full quarter higher than they were at the start of the pandemic. Personal care products (soap, deodorant, and so forth), which one might also pick up at a supermarket or discount chain, are up by less, but also have also seen a big jump:

It’s a remarkable increase. In the decade prior to the pandemic, food prices rose slower than the rate of general inflation, and personal care prices were flat.

How have the price increases affected the biggest grocery retailers? Here are sales from four of the largest food and general merchandise retailers in the US, rebased to 2019 levels:

Walmart, Target and Albertson’s saw sales increase at a pace faster than food inflation, Kroger a shade less. It doesn’t look, on the face of it, like any of these companies held prices down in the face of input inflation, then. But of course mixed into their sales results will be product mix changes, much higher volumes during the lockdowns, and changes in market share. There are other complicating factors, too. These companies don’t just sell groceries; each sells a different mix of groceries, petrol, electronics, general merchandise, household goods, and so on.

Some of this complexity should wash out further down the income statement. Gratuitous price increases should show up clearly as higher margins, whereas share and mix should have a smaller impact. Here are operating margins at the four companies through the pandemic. It is a more mixed picture:

It is probably a mistake to draw general conclusions from Target’s margins over the past few years, given its various operational problems, but I have left it on the chart as a reminder that operational issues can occlude general trends. Walmart received a temporary boost to operating margins that lasted about two years, starting in mid-2020, but it is over now. Kroger and Albertsons margins remain significantly higher than they were in 2019. Will they revert to the mean, as well? 

Higher sales and stable-to-higher margins should mean more dollars of corporate profit, though. Those dollars are best measured relative to capital invested in the business. Here is return on capital (roughly, after-tax profit divided by the sum of debt and shareholder equity):

The chart looks similar to the operating margin chart, but note that Walmart has higher returns now than in 2019; Albertson’s and Kroger are doing much better. 

The initial conclusion, then, has to be that the grocery industry, as represented by four of its largest players, became more profitable in the pandemic, and it has stayed that way for a couple of years at least. It is a good guess that price increases in excess of cost increases have played a role in this.

We will consider the profitability of the grocers’ suppliers, and how we should think about higher post-pandemic profits, in days to come. 

One good read

The Fed can go deeper.

FT Unhedged podcast

Can’t get enough of Unhedged? Listen to our new podcast, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on past editions of the newsletter here.