Inflation Now, Deflation Potential Later?

Kevin Warsh gave an important speech last Friday at the Jackson Hole Economic Symposium. He properly pointed out that Federal Reserve policy has not been especially tight, basically leaving the marketplace to reflect higher interest rates in most international markets and primarily resulting from sizable existing and still increasing structural debts and now increased AI capital spending. Inflation is very persistent as shown in increased diesel and jet fuel costs (airfares wow!), natural gas costs overseas, grains, and sporadic tariff increases, all of which impact inflation at various times.

Treasury Secretary Bessent today admitted that overall fiscal deficit spending must be addressed by both parties (taxes not mentioned), which may be needed to steer the economy and expected productivity gains promised by AI.

The bottom line could be 'inflation now, potential deflation later' IF from AI, and especially WHEN? Clearly AI has already brought some labor savings, and has assisted many businesses and industries in price optimization for improving profitability, oftentimes with increases offsetting volume losses. Considering consumer spending comprises 70% of U.S. GDP, we should not be surprised that much of AI data collection so far is tracking sensitive consumer behavior.

In only two days trading since the Warsh speech, the very important market spread between Two-Year Treasury rates and the Ten-Year Treasury rate has narrowed by .12%, fairly sizable for only two days. The Two-Year rate generally ties to Federal Funds market rates and policy whereas the Thirty-Year rate generally ties to inflation and the credibility of the borrower to eventually repay the money. So far, markets seem to be expecting short-term rate increases from the Federal Reserve, and ongoing concern about inflation and perhaps credibility keep upward pressures on the long rates. If the spread keeps coming in (tightening), history shows this would imply economic slowing concerns as well.

How might this apparent policy change impact M&A, particularly with an important Midterm election in a few months? Likely not well, because it could impact cash flows and multiples in our very consumer-based industry. Pressures on consumer spending also impact our employee base. And job worries are increasing from the potential impact from AI and its timing.

Our Convenience industry has clearly benefitted in the Covid era and beyond in a still strong overall economy. Pricing and margin flexibility have greatly improved returns, as reflected in successful c-store company selling price multiples, plus some very successful recent IPOs. No doubt, important tax change policies allowing generous depreciable asset price mark ups plus stable long-term capital gains policies have widened the range of selling multiples to record 12x multiples for more scarce, strong companies at this point of the cycle. Softer economic conditions bring reduced profitability and often expectations reflected in lower multiples as well.

For our latest updates, please follow our announcements and blogs and we are available at any time to discuss our latest thoughts. Also, please plan to meet at upcoming conventions at NACS and/or SIGMA.

Jeff Kramer

jeff.kramer@nrc.com

(303) 619-0611