Inflation vs. Deflation: Retailers fear falling prices

Before the holiday season, Walmart There was encouraging news for inflation-weary shoppers: prices for food and other basic goods were falling rather than rising. The retail giant said that if the trend continues, it will soon face deflation in some key household categories, which will be a welcome sight for consumers emerging from the worst price increases in decades.

But the retail giant pulled back this week, saying price hikes on many groceries and household essentials such as paper goods had stopped.

“There is deflation in certain categories — the possibility is still there overall — but prices are more stable than they were three months ago,” CFO John David Rennie told CNBC.

In recent weeks, business leaders have echoed a similar tune – at a time when inflation is slowing but prices are still rising more quickly than the Fed would like. Home Depot He said prices for home improvement materials have “stabilized” and not decreased. coca cola Makers of other popular brands of snacks, soft drinks and household supplies said their prices were still higher than they were a year ago. While they're planning a more modest price increase, shoppers shouldn't expect price cuts either.

“If we look at inflation over time, we rarely get into periods of sustained deflation,” Coca-Cola CEO James Quincey said Feb. 13 on CNBC’s “Squawk on the Street.” “That’s not a consumer impact.” .

The latest government data backs that up: while the rate of price increases is falling year-on-year, the latest measure of inflation came in hotter than expected. The Consumer Price Index, a broad measure used to track what shoppers pay for goods and services throughout the economy, rose 3.1% in January from a year earlier.

Food prices rose 2.6%, supported by a 5.1% jump in prices for food outside the home, a category that includes restaurant meals and vending machine purchases.

While prices are still rising across the board, shoppers have seen relief in some areas. For example, prices for consumer electronics, used cars, and some other categories of general merchandise have fallen. Wages also continued to rise, softening the blow as some prices remained high.

Inflation has jumped to the top of the minds of shoppers, executives and investors over the past two years, as rising prices squeeze household budgets and force shoppers to reevaluate where and how much they spend. Price rises helped companies offset higher input costs and maintain growth – even as consumers purchased less and were forced to spend more money. The Fed took on the difficult task of reining in rising prices without sending the economy into recession and slowing inflation, but shoppers could only feel so much relief.

The cost of everyday items topped Americans' economic concerns in a Pew Research Center poll conducted Jan. 16-21. 72% of participants said they felt “very” concerned about the prices of food and consumer goods.

While shrinkage can provide relief to consumers, it can also be difficult to deal with. In many cases, firms may choose to protect profits rather than pass on lower input costs to consumers. Otherwise, they risk shrinking sales and falling stock prices.

In addition, executives may not want to cut prices or say that deflation is occurring, as investors could view that as a sign of weakness in the company's brand or the economy as a whole.

“You rarely see prices fall on a uniform basis outside of recessions or deep recessions,” said Gregory Daco, chief economist at EY.

But he said consumers sometimes benefit from price “corrections.” For example, airline ticket prices fell during the pandemic and then rose afterward, but have now stabilized again.

So far, the breakdown of historical inflation has been mixed.

Products like chicken or eggs will likely see price drops within the grocery store. Tyson Chicken prices fell 3.9% in the fiscal first quarter, she said. Egg product Cal Maine Foods It reported that the average price per dozen eggs halved in the quarter ending December 2 compared to the same period last year, when egg prices rose. Unilever CFO Fernando Fernandez also called for price cuts on take-home ice cream, wash bars and skin cleansers in a conference call held by the company on February 8.

“We saw the contraction first in commodity-oriented categories,” said Arun Sundaram, an analyst at CFRA. “I think it will take some time before packaged food prices come down.”

But not all commodity prices fell. Cocoa, sugar and tomato prices have risen recently, hurting companies like them Kraft Heinz And Nestle. Chocolate maker Hershey It said it raised prices slightly on some items earlier this month.

Although many input cost pressures on companies have eased, expenses are rising faster than before the unprecedented demand boom in 2021. Most companies are seeing costs rise by about 3%, which is still higher than pre-pandemic inflation, which was It ranges between 1% and 2%, according to Edward. Jones analyst Brittany Quattrocchi.

Strongly branded items, such as soft drinks or snacks, typically have more pricing power and less competition than private-label products because of their distinct flavor or fan following. This gives makers the ability to continue raising prices to mitigate rising costs, even as their volume declines.

On the other hand, customers are more likely to substitute a cheaper or store brand product for items that don't have a unique flavor or taste, such as a container of peanuts. That's one reason why Kraft Heinz sold its nuts business to Hormel three years ago.

“The more ingredients in a product, the more pricing power you usually have,” Sundaram said.

Retailers, including Target and Kroger, have introduced new private label brands to better compete with national brands and undercut their prices. Earlier this month, Target debuted Dealworthy, a brand consisting of products including dental floss, paper towels and shampoo. Most brand new items sell for less than $10.

By stealing sales, retailers can pressure national brands to lower the price of an item, offer a cheaper version, or offer a discount.

Some industry watchers expect a big wave of price cuts as food makers struggle with weak demand and lagging sales growth.

A number of food suppliers reported shrinking production volumes in North America in their recent quarters, including Pringles maker Kraft Heinz. Kelanova And PepsiCo Food sections. Volume does not include price and currency changes, giving investors a more accurate view of demand.

These softer trends will force brands to lower their prices or give customers another reason to buy their products, such as offering a short-term promotion or innovative features, said Brad Thomas, a retail analyst at KeyBanc.

“The ongoing ‘adversarial’ relationship between retailers and suppliers – pushing for lower prices – is part of the normal course of business,” he said. “What's different about what's happening now is how big the CPG is [consumer packaged goods] Brands lose.”

Home food prices are expected to turn negative later this year. CFRA's Sundaram echoed that prediction, while noting that costs should continue to decline as well.

Historically, food deflation occurs about once a decade and lasts about eight months, according to Thomas. The last time was in 2016 and 2017, Walmart was the big winner. Rival Target didn't see the same benefit.

Even some of America's biggest brands have indicated that consumers' ability to afford higher prices has weakened. Some companies said they had raised prices or pledged that the increases would be more modest this year.

For example, Kraft Heinz said on February 14 that it expects its input costs to rise 3% this year; However, owner Oscar Mayer plans to raise prices by only 1%. The company relies on productivity savings to make up the difference.

PepsiCo executives also said they expect a return to more “normal” prices in 2024. In the fourth quarter, Pepsi's prices for its North American Frito-Lay business rose 5%, while prices for its North American beverage unit rose 9%. Compared to the previous quarter. period of last year.

However, Thomas admitted that brands with a strong following, such as Coca-Cola, are likely to keep products more expensive. Mid-tier brands are more at risk and will have to lower their prices.

Just as inflation has become a dirty word, so too can deflation, said Greg Milich, retail analyst at Evercore ISI.

“High inflation is bad, but deflation is bad too, because you have fixed costs that don’t go down,” he said.

Wage costs rose as new minimum wage laws took effect and the labor market remained tight. Many food companies are restricted by supplier contracts signed when the cost of goods is higher.

Deflation can also cause concern that a company's overall revenues may decline.

According to KeyBanc estimates, a 1% drop in food prices would add $1 billion a month to consumer spending, and low-income families would benefit the most. But shoppers can choose to hold on to those savings rather than spending the extra money.

For example, Home Depot has seen lumber prices decline over the past year, but is still seeing weaker demand for larger home projects amid rising interest rates. Best Buy sells consumer electronics, another contractionary category, but has struggled to boost sales after a buying boom during the pandemic and with product innovation lagging.

If customers spend less on necessities like food, they may buy more discretionary items, “but you can't assume there's a one-to-one conversion,” Mellish said.

Wall Street reflected those concerns in November when Walmart said a downturn could be coming soon. Shares of the retail giant fell about 8%, their worst day in more than a year at the time. (Walmart shares were hovering near all-time highs.)

Richard McPhail, Home Depot's chief financial officer, acknowledged the laden meaning of deflation in a recent CNBC interview.

“I'm very cautious about the word 'deflation' because of what it represents in people's minds,” he said.

MacPhail described prices as “stabilizing” and not declining. The home improvement retailer hasn't seen “significant price movement” since early August, he said.

Even as Walmart widely downplays deflation expectations, CFO Rennie said the discounter ultimately believes lower prices will be a good thing.

Walmart has seen contraction in its general merchandise categories, although food prices are still rising in the low single digits year over year.

“To be very clear, we want lower prices for our customers,” Rainey said.

CNBC's Christopher Hayes contributed to this report.