"We've had a really unfortunate situation where we've had three very, very different inflation waves caused by very different things," UBS Global Wealth Management Chief Economist Paul Donovan told Yahoo Finance (video above). "And they've just come one after the other. So it looks like you've had this continuous period of inflation."
The first wave, primarily in consumer durable goods, "was demand-led," Donovan explained. "That's over. Durable goods prices in the States are falling. You've got outright deflation."
That was followed by a second wave of supply-led inflation, he added, "and that was the energy shock coming out of the war in Ukraine." And then "the third wave of inflation — the one we're getting now — is this unusual profit-led inflation story."
Sometimes called "excuseflation" or "greedflation," profit-led inflation occurs when consumer-facing companies toward the end of the supply chain persuade shoppers to accept price hikes by pointing to plausible explanations (such as historically-elevated inflation). However, Donovan said, the true reason for these elevated prices could have more to do with expanding margins and keeping investor sentiment high than with increased input costs.
"It's using excuses," Donovan said. "It's using a cover."
Why inflation remains sticky
The main drivers of higher prices are the costs of goods sold — which includes both material and labor costs — and corporate profits.
Fortunately for consumers, prices for materials have slid tremendously. The World Bank expects a 21% decline in commodity prices in 2023 relative to 2022 — which, it noted, would be the sharpest drop since the COVID-19 pandemic.
However, prices still hover well above average levels from 2015-2019. During the first quarter of 2023, certain companies continued to institute price increases even as they witnessed flat or declining comparable sales volumes.
"I think what you see going on as much as anything is, one, obviously we've taken some pricing to cover the inflation that we've been dealing with," PepsiCo (PEP) CFO Hugh Johnston told Yahoo Finance. "As consumers move to smaller size packages, it affects volume a little bit as well. But overall, the demand for our products continues to be quite high."
Elevated labor costs may be the larger quandary for an inflation-fighting Federal Reserve — and a viable explanation for businesses pushing through price increases.
"What I think will be the bigger story this year for the broader economy, especially for the Fed, will be these stickier labor costs," Charles Schwab Senior Investment Strategist Kevin Gordon told Yahoo Finance.
"Look at unit labor-cost growth — it is still way above trend, pre-COVID trend — and the fact that you're not really seeing an easing in productivity growth or lack thereof because it's still deeply negative," he said.
"So that convergence, I think, will be really important because companies can only stomach those higher labor costs for so long, especially if you're not getting that revenue back and that revenue surge."
However, corporate profits have also played a large role in price increases since the disruptions from the coronavirus pandemic took hold.
According to an analysis published by the Economic Policy Institute, corporate profits replaced unit labor costs as the largest contributor to unit price growth in the nonfinancial corporate sector from the second quarter of 2020 to the fourth quarter of 2021, when compared with historical averages from 1979-2019.
"[Corporations] sneak in a margin increase," Donovan said. "And you can see this with, for example, the rise in retail profits as a share of GDP. That's one instance where we're seeing this expansion of margin under the cover of, 'Oh, it's a general inflation problem. We can't help it.' But actually, they're expanding margin and just basically persuading consumers to accept that."
How long before companies rethink 'excuseflation'?
Another reason companies may feel comfortable raising prices has been the continued strength of consumers.
During the first quarter of 2023, a host of company executives said US consumers were "healthy" and their spending remained "resilient", while also detailing price increases and profit preservation efforts to investors and equity analysts.
"After slowing in the back half of 2022 a bit, we saw the pace of payments picked back up in quarter one, especially in the latter parts of the quarter," Bank of America (BAC) CEO Brian Moynihan said during the company's Q1 earnings call. "Consumers' financial position remains generally healthy. They're employed with generally higher wages, continue to have strong account balances, and have good access to credit."
In June, however, Moynihan acknowledged that spending has "slowed down" following a succession of Federal Reserve interest rate increases. There's also evidence that higher prices are weighing on consumer confidence.
For instance, consumer sentiment slid 7% in May, "erasing nearly half of the gains achieved after the all-time historic low from last June," Joanne Hsu, director of the University of Michigan's Surveys, said in its most recent report. "That said, consumer views over their personal finances are little changed from April, with stable income expectations supporting consumer spending for the time being."
While profit-led inflation can help preserve near-term profits for a company, it could also be detrimental to a brand's image if consumers see the reasons for raising prices as disingenuous — particularly as social media provides a new outlet for consumers to push back.
Donovan said that a company's brand can be damaged if it's accused of "profiteering" at a time when people are suffering.
"Remember, we've had two years of negative real-wage growth across the developed world — people are feeling the pain," he said. "So I think that social media can help inflame profit-led inflation by creating excuses that companies can use. But it can also work by threatening brand values to cause companies to rethink some of their pricing strategies."
Because of that, profit-led inflation won't last forever, Donovan said.
"At some point, either governments or consumers realize that this is going on, and they say, 'Hold on, that's not fair,' and then you start to damage brand values," he said. "You're seen as cheating or unfairly treating the consumer. And that's exactly the point that we're now starting to get to."
Brad Smith is an anchor at Yahoo Finance. Follow him on Twitter @thebradsmith.