Rising Production Costs Undercut “Transitory” Inflation Narrative

In yet another sign inflation might not be transitory, over 85% of manufacturers reported increasing prices in July in the most recent manufacturing ISM report. At some point, producers will have to take steps to mitigate the impact of rising prices. That means passing costs on to consumers, cutting costs, or some combination of the two.

If more companies begin to pass rising production prices on to consumers, we’ll see CPI continue to spike.

CPI has already come in hotter than expected every month this year. One analyst said he thinks the pace of price increases could accelerate even more through the back half of the year.

I think a lot of companies have been reluctant to pass on their higher costs to the end consumer. … So, I think by the end of the year, or as we get closer to the end of the year, a lot of companies are going to be under significant pressure to pass on these higher costs.”

Some companies have already hiked prices. For instance, in June, Chipotle announced a 4% increase in menu prices to help offset its higher labor costs. Meanwhile, Campbell’s Soup warned it is going to miss earnings projections due to higher input costs.

Increasing labor costs have hit many companies hard. A Fox News report noted, “Companies from Target, Costco, McDonald’s to theme parks such as Disney World have taken similar steps to bump employee pay.”

And how do you think these companies will pay for these wage hikes? You can be certain the cost of everything from your Target t-shirt to your McDonald’s Mac is going to go up.

But it’s not just labor costs hitting producers, as comments from the July ISM survey reveal. A respondent from the food, beverage & tobacco products sector noted, “Still dealing with price increases from force majeure issues as well as overseas shipping premiums and higher costs of items like fuel.” Others mentioned rising commodity prices. A respondent from the computer and electronics sector flat out said, “Increased costs are being passed to customers.”

Of course, not all production costs get passed on to consumers. But that’s not necessarily good news. Companies can’t just eat rising prices. If they don’t pass them on to their customers, they must take steps to reduce costs. That often means cutting its workforce. If companies can’t pass costs on to their customers, they may have to resort to layoffs – not something you want to see in a labor market still struggling to recover.

Companies also sometimes find ways to subtly pass on costs without directly raising prices. This is known as “shrinkflation.” You can see this in your ever-shrinking toilet paper rolls.

The bottom line is there is no sign that rising prices are going away any time soon. This makes Fed Chair Jerome Powell’s constant use of the word “transitory” seem a bit dubious.

We can’t just pretend and play make-believe and hope the problem goes away. They tried that with the mortgage problem. Even though it was obvious that subprime was the tip of a huge iceberg, the Fed kept saying, ‘Don’t worry. It’s contained,’ because they were hoping that if they denied the problem, maybe it would go away. Well, they’re doing the same thing again with inflation. They’re telling all the people who are so worried about inflation, “Hey, don’t worry about it because it’s just transitory.” Well, it’s as transitory as subprime was contained.