While the cost of capital remains relatively inexpensive and consumers keep their foot on the pedal of the economy, the recent inflationary surge will likely drive the Federal Reserve to act to cool the economy. The big question: Can the Fed apply the brakes without slowing the economy into a recession?
In March, inflation rose 8.5 percent, a 40-year high, according to the latest reading of the Labor Department's consumer price index, or CPI. Meanwhile, groceries surged 10 percent in March from a year ago, while food overall rose 8.8 percent. Used-car prices are more than 35 percent higher than they were a year ago, dropping slightly since January, and nationally a gallon of gas is currently hovering at around $4, up 18.3 percent in March and nearing a record set in 2008.
While economists expect inflation to have peaked in March, the pace should level off or fall only gradually. What's more, the broad-based uptick in prices may prompt a more aggressive response from the Fed, whose job it is to tamp down on inflation--which, in this case, is spurred by global supply chain issues, another Covid-19 wave, and the Russian invasion of Ukraine. After broadcasting a more moderate slate of six rate increases this year, Fed Chair Jerome Powell is now widely expected to support a more robust rate hike, or 50 basis points, compared to the low-end of the range, at its May meeting. The Fed boosted the benchmark federal funds rate (the interbank lending rate) by a quarter percentage point in March, the first rate increase since 2018.
The Fed's action is liable to be both good and bad for small businesses, which have already survived a punishing two years amid the pandemic. It could be good in the sense that higher rates could throw cold water on overheated prices in volatile segments, including energy and food, for instance. But it could also be bad, in the sense that an overreaction from the Fed could kill demand and inadvertently send the country hurtling toward recession. While the latter could indeed tamp down on inflation, it would also imperil the economy's growth and lead to layoffs.
Ratcheting up the hikes a few basis points doesn't alarm Robert Litan, an economist and nonresident senior fellow at the Brookings Institution, a nonpartisan think tank in Washington, D.C. He notes, though, that the U.S. would be hard-pressed to escape this inflation cycle without any collateral damage, no matter how slowly the Fed hikes rates.
"In my memory, the Fed has successfully only once engineered a soft landing from an inflationary spike, and that was in 1993-1994," says Litan, who will be 72 years old next month. "That, to me, says the odds are 50 percent--if not higher--that we're going to have a mild recession at some point."
For businesses already contending with supply chain chaos and attendant higher materials and shipping costs, the prospect of slowing down the economy is grave. "When the pandemic started, we saw slight delays in projects," says 41-year-old Chris Doyle, the president and CEO of Billd, the Austin-based materials financing platform for contractors. "I think this year is super critical ... there will be a lot of businesses that don't last."
Of course, slowing down the relentless price hikes would be a welcome result of the Fed's actions. Doyle notes that commercial contractors have been seeing prices surge 50 percent to 100 percent for everything from lumber to steel, as reams of building products are on three-day pricing indexes--meaning that suppliers recalibrate prices every three days.
In preliminary findings from an industry report conducted by Billd, Doyle notes that 75 percent of contractors said the volatility and increase in material prices negatively impacted their business in 2021, while 88 percent expect conditions to negatively impact their business in 2022.
He worries that continued price increases would eventually cut into sales. For instance, a home or property owner could push off a renovation. What's more likely, he says, is that contractors end up eating the higher costs and eventually start to curtail less-profitable projects. "If you don't have folks going out of business, you'll see them being very selective about the work they take," says Doyle, noting that the labor crisis is hitting the construction industry particularly hard. "That will have a reverse effect where it's not just a labor shortage, it's a business shortage."
Businesses are attempting to diversify and get crafty, naturally. As for Billd's clients, Doyle says the smart ones are introducing variable pricing into their contracts, so they're not locked into a number, knowing that number may tick higher.
Jeff Neal, the 37-year-old founder of Lancaster, Pennsylvania's Critter Depot, a seller of bugs used for animal feed, says he recently expanded the product line to include egg-laying hens, which have been a growing source of sales, while sales overall have slowed 25 percent from a year ago. He's also attempting to market an existing product--Black Soldier Fly Larvae--as a composting worm, with the goal of getting homesteaders to bite: "They haven't gotten [us] out of the hole, but they're definitely providing some much-needed support, and an additional [revenue] provide[r] we can offer in the future, as well."
"We had to get innovative," says Neal. He notes that the cost of his business's shipping materials--including tape, boxes, and egg cartons--have increased 30 percent, while the feed mills that produce the material his bugs eat have raised prices 40 percent. Neal adds that the business's energy costs have also spiked and a couple of employees have asked for raises.
While Critter Depot has not yet raised prices, Neal says he's considering it. As are a lot of businesses. "We know that inflation is hitting consumers," he says. "Our concern is that by raising our prices, we're going to miss out on sales that we need."
It adds up, says Doyle. A sales slump, while still reeling from higher costs, for too long a period can be too great for some companies, he says: "It's putting the pressure on the small businesses, who are the ones doing the work ... These are the entrepreneurs that are building our country."