**What’s Next for Profits? Cars Shed Light on a Key Inflation Question.**
**How easily companies give up swollen profits could determine how easily the Federal Reserve can cool inflation. Dealerships offer clues.**
**By Jeanna Smialek, The New York Times, Sept. 21, 2022**
**Many companies have been able to raise prices beyond their own increasing costs over the past two years, swelling their profitability but also exacerbating inflation. That is especially true in the car market. While dealerships are paying manufacturers more for inventory, they have been charging customers even higher prices, sending their profits toward record highs.**
**Dealers could pull that off because demand has been strong and, amid disruptions in the supply of parts, there are too few trucks and sedans to go around. But — in line with its desire for the economy as a whole — the Fed is hoping both sides of that equation could be on the cusp of changing....**
**If companies begin to lower prices to compete for customers as demand abates, price increases might slow without costing a lot of jobs. But if they try to hold on to big profits, the transition could be bumpier as the Fed is forced to squeeze the economy more drastically and quash demand more severely....** [end quote]
Cars are big-ticket items that most people borrow to buy. The Fed is hoping to cool inflation in two of the most-impactful markets – real estate and cars – by raising interest rates.
Consumer price inflation is always caused by higher demand than supply for goods and services. (It’s not a function of money supply, since a lot of money goes into the asset markets, not consumer spending.)
Dealers will not discount prices (reducing their profits) as long as demand for the product at full price stays strong.
The used car and new car markets are separate and have different dynamics.
Used-car prices have at least stopped their ascent as inventory has grown, and experts say discounting is likely around the corner.
New cars may be a different story, however, because supply and demand remain so out of whack. Customers, meanwhile, remain desperate for new vehicles. “Everything indicates right now that the consumer has been able to bear the rate increases.”
There used to be a saying, “As GM goes, so goes the nation.” Those days are long gone. But the auto industry, as a whole, is an important part of the economy (despite heavy robotics).
The housing market has slowed in recent months—with seven months of monthly sales declines through August—as the Federal Reserve aggressively raises interest rates to cool the economy and bring down high inflation. That has led to higher mortgage-interest rates and increased borrowing costs for home buyers by hundreds of dollars a month, pushing many out of the market. The average rate on a 30-year fixed-rate mortgage was 6.02% in the week ended Sept. 15, up from 2.86% a year earlier.
Domestic auto production has been falling since 2014 (including cars and light trucks). It’s currently seeing a small increase but that could be noise. Inventories are super-low, which will support higher prices.
Ford cut its 3Q22 profit outlook a couple of days ago but that was because parts shortages caused thousands of Ford’s most-profitable vehicles to sit on lots waiting to be fully assembled.
Supply chain problems are still an issue.
Of course, every industry and company is different. Homes, cars, manufacturers, retailers, service providers (70% of the economy, including landlords) – all try to maximize profits.
“Swollen” profits won’t shrink as long as demand exceeds supply. That will support stock prices.
But the decline in home sales shows that rising interest rates can cut into demand. We are seeing price drops in our neighborhood (from the extremely high 2021 peak).
Consumers have been borrowing like crazy on their credit cards since Covid restrictions ended in mid-2021.
It looks like consumers are still spending, though the increase is small.
“Swollen” profits won’t decline until supply exceeds demand and suppliers are forced to cut prices. If the Fed keeps raising interest rates until that happens, stock prices will get a double whammy.
- Lower profits. Possible dividend cuts.
- Higher discount rates for calculating Net Present Value.
And the companies will be forced to refinance their debts at higher rates, cutting profits and possibly threatening default.