Why The Federal Reserve Can’t Solve Food Price Inflation

The Federal Reserve raised interest rates another 50 basis points in January, in an attempt to tamp down inflation. Yet interest rate hikes have not yet had any meaningful impact on high food prices. The Fed can’t address a major cause of inflation: corporate pricing strategy and profiteering that is slowing down grocery sales, changing consumer buying patterns and exacerbating food insecurity.

Fed Chair Jerome Powell recently rationalized the rate hike as a way to ensure “strong labour markets”. Federal Reserve Bank President of St. Louis, James Bullard likewise thinks rates need to go up “aggressively” in 2023, potentially echoing the Volcker shocks of the 1980s which squelched the bargaining power of organized labor for a generation. Esther George, Federal Reserve Bank of Kansas City President, was surprisingly blunt, linking inflation to higher household savings, “We see today that there is a bit of a savings buffer still sitting for households, that may allow them to continue to spend in a way that keeps demand strong,” she said. Personal income and job marketoutlooks are holding steady in the meantime, while real wage growth has declined in most industries. Fed rate hikes have never been friendly to working people.

But food at home (i.e., grocery) prices continue to be elevated over last year. November food at home CPI (consumer price index) was up 12%, while overall inflation was up 7.1%. The CPI peaked in June at 9.9% while grocery price increases peaked in August at 13.5%. Thanksgivingwas the most expensive it has been in 4 decades and December holiday menus look likewise.

Price inflation has not slowed considerably because many large companies continue to raise prices higher than cost increases. About half of price inflation is due to real world factors, like avian flu (eggs, poultry), weather (potatoes and fresh produce) and supply chain fragility (pretty much everywhere). But over 54% of inflation is due to windfall profits, from food companies to fertilizer cartels to the railroadsector. All in, corporate profits hit a record $2 trillion in Q3 2022, right about the same time that the CPI hit record highs. That is not a coincidence.

Such profit inflation does not factor into the Fed calculus, but it is status quo for Wall Street. Shareholders favor firms with high levels of market concentration because they can drive up prices and increase margins without fear of being undersold. This in turn increases shareholder returns.

Earnings call transcripts are an entertaining way to see how this all plays out. CPG executives feign surprise at how well price increases have been accepted by consumers (i.e., demand elasticities). They then brag about how profitable they are and how big the dividends and buybacks will be for shareholders:

Kraft Heinz: “We’ve already increased the prices that we were expecting [to] this year, but I’m predicting that next year, inflation will continue, and as a consequence [we] will have other rounds of price increases… We have executed a new price increase in the month of August. And the elasticities turned out to be stronger than what is anticipated.”

Mondelez: “Year-to-date, we have delivered nearly $900 million in absolute gross profit dollar growth, a record high for our business, $3.3 billion to shareholders year-to-date through share repurchases and dividends. We also expect a significant contribution from pricing, and we continue to plan for double-digit cost inflation. We've announced a third round of pricing in the U.S… we still expect significant inflation in '23 and hence, the pricing rounds we have to go through.”

Pepsico: Profits were up 20% while prices increased 17% and volume slipped just 1%. “I still think we're capable of taking whatever pricing we need.” Despite this windfall, Pepsico just announced a round of layoffs, anticipating a recession and insulating their P&L from lower sales through cost cutting.

Coca-ColaKO +0.4%: Sales were “driven by pricing actions and robust volume growth” while profits spiked 14% and the company announced new “cheater” items such as smaller bottles or smaller multipacks of less cans per multipack.

Procter & GamblePG +1.2%: Sales grew 7%, with pricing added nine points to sales growth, stating “We continue to believe that the majority of that growth will be price driven with a negative volume component, as you would expect given the inflationary pressure.”

Colgate: “You’re not going to see a lot of companies chasing volume by discounting prices.”

Nestle and UnileverUL +1.1% both raised prices 10% to record levels.

Tyson: “Our pricing actions, which partially offset the higher input costs, led to higher sales during the quarter. Despite a volume decline driven by higher average sales prices last year, this time, we spent about $50 million on buybacks. This year, we've got almost $700 million.”

And speaking of higher input costs, pie shells, cereals and baked goods prices hit record levels over the holidays. Just 4 firms control 70% of the global grain trade, including wheat flour. Cargill reported record profits and a 23% increase in revenues. ADM recently saw its most profitable quarter ever. BungeBG +14.5% posted better than expected earnings. Even the normally staid Wall Street Journal noted that “Grain traders like ADM, Bunge and privately held Cargill Inc. tend to get a boost from higher commodity prices when there are shortages, geopolitical conflicts, or extreme weather events that lead to more volatility in commodity markets.” This is disaster capitalism, freshly baked.

CPG oligopolies are directly driving up the CPI, the measure of inflation consumers feel most acutely at the grocery store. Pepsico and Nestle have annual food and beverage sales around $70 billion, Tyson over $43 billion, ADM, Cargill and Coca-Cola over $30 billion and Unilever, Kraft Heinz and Mondelez well over $20 billion. Their products are ubiquitous in the food supply and price hikes are tough to avoid. Their brands monopolize shelf space and customers’ wallet share: think Fritos, Lay’s, Ruffles, Cheetos, Doritos, Tostitos: these are just a handful of iconic Pepsico brands.

And this category dominance creates a vicious cycle that keeps them on top. Price inflation and higher interest rates make investors more hesitant to invest in emerging brands that would compete on shelf with Big CPG. In turn, emerging brands don’t have deep wells of trade spend and must balance cash flow, higher costs of goods and the need for positive EBIDTA with grocery stores’ expensive slotting and promotional requirements. It isn’t pretty out there for many food startups.

But how is this set of dynamics impacting grocery stores, the main interface for customers?

US retail sales were up 7% YOY, or 1% below the CPI. This means that retail is stagnant. Dollar sales are outpacing unit growth. At grocers, the daily, weekly and monthly customer traffic is mostly down compared to 2021, according to Placer.ai. Comparative sales (comp’s) at Walmart, Kroger, Albertsons and Ahold, which account for over 45% of U.S. grocery sales, are up but still well under the rate of price inflation, so effectively negative. Like much of the industry, their unit comps are even lower, meaning a recession is already here for the sector. This hasn’t stopped retail oligopolies from passing along billions in shareholder buybacks. But it has put their pricing strategies under the microscope, particularly in light of the proposed Kroger-Albertsonsmerger. Consumers are finally reacting to price increases by reducing trips and changing purchasing habits drastically. Food retailers are getting pounded by this demand elasticity whiplash.

But comp’s are grocers’ holy grail. Once growth slows, maintaining profitability then becomes a matter of managing expenses, such as inventories and payroll. This could mean more out of stocks and layoffs. According to FMI, net profits of grocers peaked in 2020 at 3.5% and 3.2% in 2021, a 30% jump over the 10 year average, but those days are gone. Profitability, a matter of churning successively more tonnage through the same 4 walls every year, will be an even tougher challenge for the foreseeable future.

Grocery stores are hence key to the CPI leveling off. Surveyed food retailers now say they plan to pass through price changes at cost, with only 5% saying they will pad their margins by raising prices higher than cost increases. And some grocers are pushing back on price hikes where they can. That’s a big change from the last two years, when grocers bragged about the ability to harness higher margins through pricing.

Some retailers are leaning into the headwinds. Natural Grocers is focusing on fresh foods, and investing in loyalty programs and employee wages. Thrive Market is doubling down on personalization, fulfillment efficiency and customer experience. And up to 9 in 10 grocers are pushing more private label, giving them better control over supplier costs and inventories while assuring customers get lower prices.

Arun Sundaram, an analyst with CFRA Research, noted that “Food retailers are operating in probably one of the best operating environments for them in modern history. We think that the best times are probably behind [for them], and that things are going to get much more challenging down the road, especially as food inflation moderates, food-at-home demand moderates and competition continues to increase.”

But looking past grocery and CPG, what does it say about society when food consumption is trending down due to negative wage growth and high prices? This brings us back to the Fed’s interest rate tool of effectively reducing demand. It has a distinct Malthusian stench. Over 42 million Americans cannot afford to buy enough food. Over 53 million people visited food pantries in 2021. Food insecurity has doubled since pandemic stimulus programs ended and hovers at 10% nationally, while nearly 20% of Black households are food insecure. About 41 million people use SNAP, with over $110 billion in annual redemptions. Accounting for over 13% of total grocery sales, such tremendous SNAP volumes brings the grocery price inflation discussion full circle.

The Federal Reserve can’t solve food price inflation. Interest rate hikes should be off the table, but bankers are calling the shots. Meanwhile, the financial sector has reaped the windfall profits from inflation. Why poach the goose when you can keep harvesting golden eggs?

But there are other options. While a year ago price controls seemed fringe, the Emergency Price Stabilization Act from Rep. Jamaal Bowman (D-NY), made the idea mainstream. Windfall profit taxes have been implemented in India, the UK, Germany and the E.U., and were even opportunistically mentioned during election season. And if corporate agribusiness can no longer deliver what it has always promised consumers, i.e., cheap and abundant food, then maybe we need a new food industry paradigm? This could include better antitrust enforcement so that innovative new enterprises have a fighting chance against Big Food. It should also include more public investment in food systems, such as a robust public food sector that guarantees universal food access and a right to good food.

Working people can also consider collectively taking things into their own hands. Workers in locales as disparate as Bangladesh, Zimbabwe, South Korea, Tunisia, France, Spain, Belgium, Portugal, Bulgaria, the UK, and South Africa have gone on strike and walked off jobs en masse to demand higher wages that keep up with the cost of living. Maybe that’s not what Fed Chair Jerome Powell meant when he observed a “strong labor market”, but it sure beats what The Fed has been peddling.