This time last year the big inflation debate was ‘transitory versus structural’. Now that we know the winner (clue: it wasn’t transitory), the question today is how much demand destruction it will take to bring inflation back down to central bank targets.
The bottom-up view is that we may at least have reached the end of the beginning. Every month we ask Fidelity analysts what they think will happen with labour and non-labour costs at the companies they cover over a six-month time horizon. Global expectations for non-labour costs eased again in September, continuing a trend that started in March, while those for labour cost rises have reached a plateau.
Chart 1: Cost inflation remains elevated but expectations have stopped rising
Chart 1 shows the proportion of responses reporting costs are expected to increase minus those reporting costs are expected to decrease; significant increases and significant decreases receive a higher weighting. Question: “What are your expectations for total labour/non-labour costs over the next 6 months compared to current levels?” Source: Fidelity International, September 2022.
Broken down by region, analysts now expect slower growth in non-labour costs everywhere except Europe.
Chart 2: Non-labour cost pressures have started to ease
Chart 2 shows the proportion of responses reporting costs are expected to increase minus those reporting costs are expected to decrease; significant increases and significant decreases receive a higher weighting. Question: “What are your expectations for total non-labour costs over the next 6 months compared to current levels?” Source: Fidelity International, September 2022.
“The majority of commodity inputs peaked earlier in Q3,” notes one analyst who covers North American consumer discretionary firms. “Transportation bottlenecks are easing, leading to a material decline in freight rates. Semiconductors are becoming more available, meaning fewer inventory outages, leading to smoother production which means lower costs.”
Expectations for labour cost growth meanwhile fell month-on-month for several regions, with Europe again an exception.
Chart 3: Wage growth expectations appear to have stabilised
Chart 3 shows the proportion of responses reporting costs are expected to increase minus those reporting costs are expected to decrease; significant increases and significant decreases receive a higher weighting. Question: “What are your expectations for total labour costs over the next 6 months compared to current levels?” Source: Fidelity International, September 2022.
However, there is still evidence of labour market tightness, especially in healthcare and financials.
“There are significant talent retention and attraction issues across most sub-sectors,” says one healthcare analyst. “This is particularly pronounced in the US and is across both skilled and relatively lower skilled labour.”
“Cost of living increases haven't really hurt white-collar workers yet,” adds one Europe-focused financials analyst. “It will become an issue in 2023, so companies need to adjust salaries accordingly.”
Analysts expect a very different picture a year from now
Over a longer time horizon, our analysts expect overall operating cost pressures to ease substantially by this time next year, particularly in Asia and North America.
Chart 4: Operating cost inflation expected to slow substantially over next 12 months
Chart 4 shows the proportion of responses reporting costs are expected to increase minus those reporting costs are expected to decrease; significant increases and significant decreases receive a higher weighting. Question: “How, if at all, do you expect inflationary pressures within your companies’ operating cost bases to change over the next 12 months compared to the last 12 months?” Source: Fidelity International, September 2022.
For North America, the number of analysts who expect their companies will face higher operating costs a year from now is almost entirely offset by the number who expect costs will fall. This is one reason why the US Federal Reserve (Fed) might consider pausing its current tightening program to allow earlier hikes to do their work. This would also mitigate the risk of overtightening and pushing the economy into an unnecessarily severe recession.
Signs of demand destruction
Management sentiment has continued to deteriorate, our survey reveals, with leading indicators at levels not seen since the early weeks of the Covid-19 lockdowns in 2020.
Chart 5: Leading indicators firmly in negative territory
Chart 5 shows the proportion of responses reporting leading indicators are positive minus those reporting leading indicators are negative; strong negative and strong positive receive a higher weighting. Question: “What is the outlook for leading indicators over the next 6 months at your companies?” Source: Fidelity International, September 2022.
“Downtrading is gaining pace at the expense of mass market food retailers,” notes one consumer staples analyst covering Europe, referring to the tendency of cash-strapped shoppers to buy cheaper alternatives.
“This is scary given the stickiness of customer shopping habits.”
There are also signs the demand side of the labour equation may be starting to shift. Expectations for future headcount growth have fallen notably compared to earlier in the year in every region except Asia Pacific.
Chart 6: Workforce growth now expected to slow
Chart 6 shows the average of responses. Question: “How, if at all, do you expect workforce sizes at your companies to change from current levels over the next 12 months?” Source: Fidelity International, September 2022.
Analysts also report slower expected revenue growth, pressure on margins, and reduced appetite for capex, all of which bolster the notion that we are starting to see the demand destruction policymakers seem to want as a means of quelling inflation.
Seeking equilibrium
“Out of balance” is how the Fed Chair, Jerome Powell, described the US labour market in his 21 September Federal Open Market Committee (FOMC) press conference. Demand for workers has been outstripping supply for much of the period since Covid restrictions began to lift, not just in the US but in economies around the world.
Supply chain issues have created a similar dynamic for non-labour inputs. But our survey suggests such pressures are starting to ease, and that over time the same should be true for operating expenses more generally. Costs are still going up - but no longer at an accelerating rate.
