The Fed cannot control inflation and American companies are concerned

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The stock market has overcome inflation fears on its way to new records this year, but in the C-suites, concerns about input costs, wage pressures and Fed policy remain high.

According to the CNBC Global CFO Council survey for the second quarter, US finance chiefs see inflation as the biggest external risk factor their companies face, outperforming Covid-19, cybersecurity and consumer demand. The quarter-over-quarter rise in inflation concerns has been big, and virtually no CFO mentioned this in the first quarter of 2021 survey.

The survey was conducted June 1st through June 16 of 41 members of the CNBC Global CFO Council, which represents some of the largest public and private corporations in the world and collectively manages more than $ 5 trillion in market value across a variety of sectors. The poll ended on the second day of the most recent meeting of the Federal Open Market Committee, when the Fed spoke more explicitly about inflation and brought forward the forecast for an interest rate hike.

“Consumers are spending faster than businesses and governments can ramp up. The result is friction on re-entry. That means heat, ”said Diane Swonk, Chief Economist at Grant Thornton.

But in the past two weeks the market has recovered from a post-Fed swoon and set new records as the Fed continues to believe inflation is transitory and the latest national price index data has helped policy. While the year-on-year price index comparisons peaked, the month-on-month increases have slowed, for example in the case of the consumer spending index last week.

High inflation?

The latest inflation numbers are more in line with Fed expectations, rather than a sustained and set-up price hike, said Erik Lundh, chief economist on the Conference Board. On a monthly basis, pre-pandemic price hikes are still higher, but they have decreased from April onwards.

“It begs the question, have we seen the highest inflationary pressures?” said Lund. “We don’t see an escalation after the escalation.”

Consumer inflation fears peaked in May. “A bit of reassurance was how quickly sentiment polls faded in early June. Many prices have started to peak,” Swonk said, although some materials like wood are well above pre-pandemic levels even after a recent decline.

Swonk believes tensions will persist. “The good news is that most of the inflation we are seeing appears to be temporary. The bad news is that it is more severe and longer-lasting than many, including the Federal Reserve, expected. There really isn’t a muscle memory for it is the first time workers have had leverage since the second half of the 1990s. Add to this the surge in pensions and immigration losses, which were rapidly declining before the pandemic, and bottlenecks will be more common. “

Wage pressure on the labor market

In the next 6 months, the largest group of US CFOs (57%) expect the largest increase in labor costs, with raw material costs cited by 38% of CFOs. Labor cost projections in the US far exceed cost expectations in other regions. In the EMA region, 72% of CFOs expect commodities to grow the most. In the Asia-Pacific region, projections are closer (44% cite raw materials as the biggest source of cost spikes; 33% cite labor), but materials are still seen as the biggest source of price concerns.

“I can’t remember any other time when inflation has been such a high risk factor among our members as it is now,” said Jack McCullough, president of the CFO Leadership Council.

Wage pressures are the main concern of the CFOs he has been in contact with, and CFOs expect this to continue until the end of the year.

Louisville Urban League employees speak to job seekers at a Job News USA careers fair in Louisville, Kentucky, United States, on Wednesday, June 23, 2021.

Luke Sharrett | Bloomberg | Getty Images

Companies are growing fast and hiring new employees, but the talent war is on again like Covid never existed, “McCullough said. “Your greatest concern is to recruit and retain a world-class team that is just as challenging now as it has been before. In my opinion, inflation is the second largest risk factor … of course a lack of available talent will fuel inflation cycles. ”

Durable goods, which have risen sharply over the past year, should have prices modest when supply and demand balance, Lundh said, while prices in the service economy could rise after Covid and wage inflation could remain an issue. “It will still remain elevated, but maybe not as acute as we see it now. The work will still have the upper hand,” he said.

Many companies around the world have already increased their prices. EMEA companies that responded to the survey are the most likely to say they are already passing on rising production costs to consumers (45% of CFOs versus just 19% of US CFOs). But more price hikes could come: 33% of US CFOs said they’ll have to hike prices if costs continue to rise.

“Thats how it works. We just haven’t seen anything like this in a long time. It is interesting to see how resistant CFOs remain to price increases. Large companies are better able to absorb the shock of higher input costs by adopting existing technologies, ”said Swonk.

Bond rates

The results of the CFO survey show that expectations for rate hikes remain moderate.

Just over a third (36%) of global CFOs predict a ten-year government bond yield through December 31, 2021 of between 1.75-1.99%. That’s up from 19% who shared that view in the first quarter.

Twenty-nine percent of global CFOs forecast 1.5-1.74%, up from 40% who said that in the first quarter.

No US chief financial officer expects yields to hit 2% or more by year-end.

The outlook for the bond market and general economic growth makes CFOs more confident about the outlook for stocks. 47% of US CFOs say the Dow Jones Industrial Average will hit 40,000 for the first time before falling, versus 33% who expect it to pull back to 30,000 levels. Another 19% of US CFOs do not hold market talks). Globally, the bulls remain the largest group, with 46% of all CFOs calling for the Dow to rise to 40,000 and only 24% expecting a pullback to 30,000 first. Another 29% of global CFOs do not do market talks).

Fighting inflation Fed

Bond yield expectations suggest that most CFOs also view the inflation spike as a passing event. At the same time, however, finance officials are not confident that the Fed can control inflation over the next 12 months. No US CFO who participated in the survey said they were “very confident” or “fairly confident”, while 38% were “just a little confident” and 47% were “not at all confident”.

The EMEA and Asia Pacific CFOs have much more confidence in the Fed than the US CFOs.

“The Fed cannot and should not contain the surge in inflation that we see as the economy reopens. Some of it is clearly temporary and will wear off,” Swonk said, adding that the interest rate view suggests that we are short of the shortage The Fed should downplay trust in the US. “If CFOs are really concerned that the Fed cannot contain inflation in the longer term, which is a possibility, then they should forecast much higher bond yields and do whatever they can at current rates.”

The main cause for concern remains: a political misstep by the Fed that could force the central bank to hike rates faster and exceed its target, and make the economy more vulnerable to a more compressed boom / bust cycle. And the rise in rate hikes in 2022 and 2023 from 2024 or later by attendees at the recent FOMC meeting, with the majority of FOMC attendees now expecting to move before 2024, was a significant shift.

Some influential market insiders fear that the Fed is in danger of losing control of the inflation situation. Mohamed El-Erian, Allianz’s chief economic advisor, told CNBC on Monday that a recession could be the result of monetary policy missteps.

“The lack of confidence US chief financial officers have in the Fed’s ability to control inflation is worrying,” said Victor Li, professor of economics at the Villanova School of Business who previously worked at the Fed. “The cornerstone of the Fed’s price stability mandate is the central bank’s credibility. Without a credible and transparent monetary policy, it will be impossible to anchor inflation expectations.”

Li, who had previously raised concerns about Fed policy and the risk of stagflation, said the CFO’s short-term expectation of a low-interest rate policy and quantitative easing – all but confirmed by Fed Chairman Powell – for the remainder of this year the best case for the bulls when inflation turns out to be temporary. However, if inflation continues to exceed expectations, it will either force the Fed to tighten earlier and more drastically and potentially jeopardize the economic recovery and end the bull market.

The Fed’s CFO view may have more to do with a belief in control of their own destiny than with panic over a Fed monetary policy mistake.

“CFOs trust their own ability to respond to inflation more than the Fed’s ability to control it,” said McCullough.