Prairie Middle Market Perspective Winter 2024

Inflation is the hot topic in the financial markets and how will the Fed be able to return inflation to the 2.0% level the economy experienced in the pre-pandemic time. Before 2021 the prevailing inflation was very low, and interest rates were low as well. The focus on achieving growth after the great recession of 2008 led to several large European countries like France, Germany and Spain using negative interest rates to stimulate growth and avoid deflation. Similarly, the Fed employed a comparable strategy and moved the U.S. interest rate complex to near zero to support the economy through the COVID-19 pandemic economic malaise in 2020. This move by the Fed probably saved the economy and helped the U.S. rapidly recover from pandemic. However, at these artificially low interest rates the cost of debt was almost nothing, creating unusual and unsustainable economic incentives. Inflation and interest rates were near zero for so long that even with a move to a more normal interest rate environment the M&A market has been negatively impacted, leading to artificially high valuations, a wide buyer-seller bid-ask spread on valuations and low transaction volumes.

The question now is how we get back to a more normalized M&A market without too much disruption to the economy. Essentially, “can the Fed stick the soft landing” and avoid a recession. Inflation, while down from the high of 9.1% earlier in 2023, has been ensnared in the mid-3.0% range, well above the Fed’s 2.0% target. The Fed cut rates four times for a total of 100 basis points earlier in the year but has kept interest rates at the same level since July 2023. Fed Chairman Powell remains cautious and in his last pronouncement suggested that the Fed will be data driven and will use additional rate increases if necessary to tame inflation. When will the Fed commence rate cuts is the current parlor game. A growing number of market followers believe this will occur sooner than later because the Fed’s mission is accomplished. For example, former Fed Chairman and current Treasury Secretary, Janet Yellin declared in a January 5th CNN interview that the Fed has already achieved the soft landing.

While many believe a soft landing is happening, other noteworthy business executives like JP Morgan Chairman, Jamie Dimon, in a January 9th interview with Fox Business Maria Bartiromo, remain skeptical of the soft-landing economic scenario. Mr. Dimon believes that the consumer is stretched and will reduce spending and the turmoil around the world will lead to a pullback in the global economy. Another contrary view is in the December 2023 Conference Board Economic Forecast for the US Economy. Their report is similarly skeptical and suggests that the U.S. economy will contract in the first two quarters of 2024. Two quarters of economic contraction used to be called a recession and probably be called that if the forecast turns out to be correct.

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