Corporate profits have been trending down. That’s what the Federal Reserve wants to see.
Corporate profits have been trending down. That’s what the Federal Reserve wants to see.
During the pandemic, corporate profits took off into the stratosphere. And by the middle of last year, they were running almost 50% above their pre-pandemic peak.
But since then, corporate profits have been on a downward trajectory.
We’re going to get an update on that Wednesday, when the Bureau of Labor Statistics puts out its updated gross domestic product report for the third quarter. But what are those falling corporate profits telling us about the broader economy?
One reason corporate profits are lower than last year is that labor costs are up, said George Pearkes, macro strategist at Bespoke Investment Group.
“That’s a combination of wage growth and tight labor markets, really dating back all the way to 2019,” he said.
But the bigger reason is that consumer demand is tapering, he added.
People aren’t getting any more money from pandemic relief programs. They’ve also burned through a lot of their savings.
“I mean, there’s a wide range of different explanations for this, but consumers are much, much less interested in spending at the pace they did earlier in the expansion,” Pearkes said.
High interest rates play a role too.
Bill English is a finance professor at Yale and a former staff member of the Federal Reserve’s Board of Governors.
He said the central bank’s rate hikes haven’t only slowed household spending. They’ve also raised borrowing costs for corporations.
“And as a result of their higher interest costs and lower profits, firms are likely to retrench some. So they’ll pull back a bit,” he said.
And that, English said, is exactly what the Fed is trying to encourage.
“The Fed wants to slow spending, and lower corporate profits will discourage firms from investing as much and expanding their activities as much,” he said.
We’re already starting to see that play out in certain parts of the economy.
Shannon Seery Grein, an economist at Wells Fargo, said the manufacturing and wholesale industries have cut back on equipment, inventory and other capital expenditures because overall they’re making less money.
“Your manufacturing and wholesale industries have seen some of the most significant declines in profits, which I think is consistent with what we’ve seen in the broader economy, as well, in those sectors,” she said.
But even though profits are moderating, they’re still higher than they were before the pandemic.
After all, plenty of people are still going out and spending. As a result, Grein said, corporations generally haven’t started cutting back on their biggest expense: labor.
“It’s sort of like the chicken and the egg, right? Do you have to see the slowdown in demand first? Or do you have to see firms starting to lay off their workers?” she said.
If hiring slows down, Grein said, so will consumer spending. And then, so will profits.
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