Joel Lerner | Xinhua News Agency | Getty Images
The outlook for markets and macroeconomists has been all about the US consumer this year. As inflation continued and the Fed turned hawkish, confidence focused on the economy’s ability to withstand the conditions and on continued consumer strength.
But what if strong consumer spending, which the data suggests is still the case, is the final curtain on this phase of economic growth, rather than another act in the bull market? Ultimately, consumer demand and a throttled supply chain’s inability to keep up could mean the Fed will have to become even more hawkish than it’s currently telegraphing to control inflation.
That’s the view of chief financial officers who took part in a recent CNBC CFO Council discussion on the central bank, interest rates and the economy. CFOs of top companies across all sectors of the economy suggested that the recent bear market in equity markets may be early, but not necessarily out of place. While the Fed’s monetary policy tools can help dampen demand, there is not much the central bank can do to sustain supply, and its policy plans to date will not be enough to change the global economic equation.
“I am confident that we will bring inflation back to our 2% target,” Minneapolis Fed President Neel Kashkari told CNBC Monday morning. “But I’m not sure yet how much of that burden we have to carry instead of getting help from the supply side,” he said.
In short, that’s the big concern of CFOs.
The outlook for where rates will end has shifted significantly to the upside, with the biggest rise between Fed meetings in over a decade, according to the Fed’s latest CNBC survey. And CFOs expect higher upside risk for interest rates, which are far from a surefire mechanism to avoid inflation. With inventory issues being perpetuated by consumer demand and further exacerbated by recent shutdowns in China caused by Covid and geopolitics, the supply chain’s ability to meet demand may not change.
This Wednesday’s April CPI, with headline inflation still expected in the 8% region, will be the focus of the inflation peaking debate.
CFOs on the recent CNBC CFO Council conference call took the view that even if the Fed is not currently talking about a 75 basis point hike — Chairman Jerome Powell said at last week’s FOMC meeting that it is not actively being considered — this could prove to be a negative rather than a positive in the fight against inflation. The Fed’s focus on “a few 50s” — raising rates by 50 basis points — is not surprising as the central bank emphasizes a data-driven approach and wants to see the results of its actions into late summer and early fall. However, this raises concerns among CFOs that this will fall short in response to the current inflationary environment.
A recession seems inevitable according to several CFOs as inflation is already embedded and the longer it persists the harder it will be to squeeze out of the economy. CFOs fear there are more heavyweights ahead and rates will rise higher than the Fed’s forecast of 2% to 2.25% by the end of the year and a final rate of just over 3%.
Companies keep talking about their ability to pass price increases on to customers, but that price strength seems to be waning as a source of confidence for the C-suite. There is $2 trillion in excess savings and to date consumer spending not only matches inflation levels but exceeds them in terms of real spending data.
Travel is an example of where spending is accelerating. Consumers are also “trading up,” a trend noted by several CFOs, ranging from buying more expensive seats and premium cars to visiting more expensive restaurants, with companies like Procter & Gamble finding that their most expensive items are the most popular, and big-ticket home renovation projects, which are at record levels according to builder data.
While high prices, and particularly gas prices, have caused consumer sentiment to fall, the actual numbers among middle-income households do not point to major financial strains. For the average driver who drives 12,500 miles per year, the increase in gas prices equates to about $10 per week, and for middle-income consumers it won’t result in much of a change in spending patterns.
Recent transaction data shows larger purchases in travel, furniture, appliances and electronics, all signs that high-end consumers are overwhelming those who are actually struggling.
Consumer debt is growing at its fastest pace in a long time, up to $16 trillion in Q4, according to the New York Fed, and its latest outlook for consumer debt through Q1 2022 will be released this week, with many of them expect this to be record levels, beating 2019. Last month, credit card balances rose $52 billion, more than double expectations and the biggest monthly increase on record.
Wage growth data, meanwhile, has tended to focus on the fact that the rate is still lagging behind inflation, but overall the picture is different: the total wages going to workers are above inflation as the economy about 2 million new people to work this year. This stems from household balance sheets that CFOs said were not only good, but also had plenty of untapped firepower, with more workers returning to the workforce, in many cases spouses, improving the situation for middle-income households.
But consumer balance sheet as a recession stopper is not an idea CFOs want to embrace as the supply chain remains stressed. In fact, the idea has been called naive. Ultimately, as demand continues to outstrip supply in developed markets, the Fed will have to step on the brakes and could charge interest rates as high as 5% to curb demand. That’s a recession maker, and if it’s not a severe downturn, then it’s not a mild recession either.
Not only the consumer is strong now. Corporate investment and spending also remain strong.
Concerns about the technology sector, which has driven the stock market lower and where private company valuations have plummeted, may be early, but again, they are not wrong. An email from Uber’s CEO to his employees Monday outlined a “seismic” shift in how investors view the company and the need to quickly focus on free cash flow. But private tech companies’ cash balances are at an all-time high and above where they were in 2019 and 2020 because of the fundraising they’ve made over the past year, and these companies continue to spend without the impact of inflation. This is an area where data could dampen next year. The real-time cash balances of cash-burning tech companies become cash-strapped after six to nine months. Credit markets are already beginning to tighten, which is a sign of typical late-cycle behavior.
That means a slowdown in the market’s most important sector, but close to imagining that, by and large, companies can make decisions about inventory, production, and investment and spending that avert a recession. As the market becomes more convinced that a recession is inevitable, there is an argument that companies may be the ones slowly deflating the bubble – the Fed’s “soft landing”.
The CFOs polled by CNBC weren’t betting on that outcome.
Stopping inflation amid supply chain arrears will be problematic, with Covid and war adding even more to an inventory imbalance that is lingering, forcing the Fed to act more than it has been willing to let on.
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