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Tesla's Earnings and the Fed's Inflation Dilemma

Plus500 | Thursday 19 October 2023

As the week comes to a close, Tesla fell short of analyst expectations while musings about the future of interest rates set by the Federal Open Market Committee raised questions regarding the fight against inflation. Let’s take a closer look:

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Tesla Earnings Hit the Brakes

In Tesla's (TSLA) recent financial update on Wednesday after market close, the company faced significant challenges, including falling profit margins and concerns from CEO Elon Musk about the unpredictable economic environment. These difficulties were exacerbated by weaker-than-expected third-quarter earnings. Tesla's shares also suffered, declining by more than 4.8% over the course of trading on October 18th.

Tesla has been grappling with declining profit margins, which have fallen below the levels previously set by its former CFO. To counter this, the company is aggressively cutting internal costs. Musk expressed concern about the economic climate and described himself as "paranoid."

Elon Musk emphasised that Tesla is a resilient company, but even the strongest ships can face challenges in a storm. He acknowledged that high interest rates, ongoing wars, and the production ramp-up for the Tesla Cybertruck have created a challenging environment for the company. The first stainless steel Cybertruck is set to be delivered on November 30, but volume production and significant cash flow from the pickup may take another 18 months.

Tesla has been implementing price cuts throughout the year, even on its high-end Model X, with discounts exceeding 30%. This strategy aims to maintain sales volumes and support customers affected by high inflation and interest rates. 

Despite these efforts, Tesla missed both earnings and sales expectations for the third quarter. Profit, excluding certain items, was 66 cents per share, falling short of the estimated 74 cents. Revenue reached $23.4 billion, while analysts expected $24.06 billion.

Moreover, the company's automotive gross margin, excluding regulatory credits, dropped to 16.3% in the quarter, below the expected 17.7%. Additionally, Tesla's vehicle deliveries declined for the first time in a year, with 435,059 vehicles delivered globally in the period, largely due to planned factory downtime.

Elon Musk revealed that Tesla still intends to build a vehicle factory in Monterrey, Mexico, but the company is cautious about going full-throttle with construction due to the global economic conditions. Industry analysts remain sceptical about the plant's contribution to Tesla's delivery growth over the next few years.

Despite these challenges, Tesla remains committed to its goal of producing and delivering about 1.8 million vehicles this year. However, it will need to accelerate production in the fourth quarter to achieve this ambitious target. Tesla's resilience and innovative approach will be critical in navigating the stormy economic waters and continuing its growth in the electric vehicle market. 

In addition to the aforementioned factors, Musk noted that interest rates are another challenge facing the firm.

Interest Rate Concerns Rise

The Federal Reserve's persistent struggle to bring inflation down to its 2% target has raised questions about the feasibility and cost of achieving this goal. The central bank's forecasts suggest that it may not reach this target until 2026, leading to concerns that maintaining the current path could result in prolonged higher interest rates or even more drastic rate hikes, potentially causing a recession. Consequently, there are growing calls to reconsider the 2% inflation target and aim for a more realistic goal that better suits the current economic environment.

The 2% target, established over a decade ago, is central to the Fed's mission of ensuring price stability. It strikes a balance, being moderate enough not to harm consumers and businesses but also high enough to prevent deflation, where prices decline and economic activity slows. Some argue that it may be impractical to achieve this target in the near term due to uncontrollable supply-related shocks, such as geopolitical conflicts and labour strikes.

Advocates for a higher inflation target argue that it would provide the Fed with greater flexibility, reducing the need for continuous rate hikes or maintaining higher rates for extended periods. These rate hikes can have adverse economic effects, including job losses, more expensive household borrowing, and slower growth.

Jason Furman, an economics professor at Harvard and a former Obama administration economist, has suggested that the Fed consider raising the inflation target when it updates its strategy around 2025. However, Fed officials, including Chair Jerome Powell, have resisted changing the target, citing concerns about undermining expectations about future price increases, which could influence actual inflation rates.

The proposed change in the inflation target faces credibility challenges, especially after the Fed's previous assertion that inflation would be transitory. Critics argue that altering the target now would erode the Fed's credibility.

Despite the resistance to change, Powell has acknowledged the possibility of a long-term review of the inflation target. Some experts advocate a more comprehensive overhaul, suggesting that central banks need to reevaluate their approach, particularly in the face of supply-side inflationary shocks driven by factors like the COVID-19 pandemic and geopolitical events.

These critics argue that the traditional inflation control model, which focuses on managing demand-side factors, may no longer be adequate to address the modern-day inflation challenges posed by supply-side shocks. As supply-side shocks continue and potentially worsen, they believe central banks need to shift their approach and emphasise a different set of factors affecting inflation.

In conclusion, the debate over the Federal Reserve's 2% inflation target has intensified as the central bank struggles to achieve this goal. While some argue for a higher, more realistic target, the Fed remains resistant to change, citing concerns about credibility and the impact on expectations. Nevertheless, a broader review of the inflation goal and a reevaluation of the factors driving inflation may be necessary to adapt to the challenges of the modern economic landscape. (Source:Yahoo Finance)

As the economic landscape continues to change, various factors, from the interest rate and beyond, will continue to make their mark on the earnings of global firms like Tesla. What the closing months of 2023 have in store for traders and investors alike remains to be seen.

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