Good morning. If I were Elon Musk, I’d try to buy OpenAI, too: he owns a competitor, xAI, and in Tesla’s stock he has a very, um, richly valued currency to pay with or borrow against. His $100bn-ish offer (briskly declined by OpenAI CEO Sam Altman) is less than a tenth of Tesla’s market cap. It does seems a massive underbid, though, given what Microsoft, Alphabet and Meta are investing in AI. But in the unlikely event that an increased bid was accepted, it would make a hairy test case for the Trump administration’s antitrust policy. Does the US have a national interest in encouraging competition in AI? And how does that interest weigh against the national interest in having the biggest, best-funded AI competitor globally? Send me your thoughts: robert.armstrong@ft.com.
Fast food’s struggles
McDonald’s reported fourth-quarter earnings yesterday and the results were solid in aggregate. The international restaurants led the way. The US continues to be something of a problem, though: same-store sales fell from a year ago, as the average customer order shrank. Management said that comparable sales would have risen were it not for a food safety issue (onions, e coli), but things have been sluggish in the US for a while, and for much of fast-food industry:
The industry pushed prices aggressively during the Covid-19 pandemic and has been forced to retrench with cheap meal offers. But the underlying issue is that lower-income customers in the US remain under financial stress. Here is McDonald’s CEO Christopher Kempczinski speaking yesterday:
The overall market is pretty muted. And a big part of that . . . is still that low- income consumer . . . I’m talking industry numbers right now, but that low-income consumer in the US in the fourth quarter was still down double digits. And as you know, that low-income consumer is overweighted in the industry relative to the US in total.
It’s a two-track economy, in short. That fits with the fact that, of the five restaurants in the chart above, Taco Bell is performing the best. As I learned as a college student, on a cost-per-calorie basis, Taco Bell is really cheap.
Might the worst be behind the lower-income consumer? Food-away-from- home inflation in the CPI index peaked at almost 9 per cent two years ago, but was still running at 3.6 per cent in December. And the recovery in consumer sentiment, as measured by the Michigan survey, has largely skipped the bottom end of the earnings spectrum:
For poorer Americans, there is an awfully long way to go.
Energy prices and inflation, part two
Yesterday’s letter discussed the link between oil prices and inflation — particularly the break-even inflation component of Treasury yields. The US Treasury secretary, Scott Bessent, is keen to bring long Treasury yields down and thinks that lower energy prices will play a critical role in that. But I suspect the strong correlation between break-even inflation and energy prices is driven by a third factor that influences both — economic growth — rather than any particularly strong link between the two. Remember, direct energy costs are less than 7 per cent of GDP, and a similarly small contributor to inflation indices.
To see if others shared my suspicion, I emailed assorted economists and bond mavens to ask their views.
Rick Rieder, who manages several trillion dollars as BlackRock’s chief investment officer of fixed income, agrees with Bessent that energy prices are crucial:
Bringing energy prices down will definitely help move 10-year rates lower. It is one of the most critical components impacting overall inflation because of its broad transmission through the economy.
Others say it’s hard to see why energy prices would play such a special role. Paul Ashworth of Capital Economics makes the obvious point that inflation is about price changes, not price levels: “There is a surprisingly good relationship between [energy price levels and break-evens], although we’re never sure why because theoretically it should be the change in oil prices that matters for inflation expectations.” James Athey of Marlborough Group elaborates:
It’s not a good argument theoretically . . . but empirically it has some sway. Markets should take higher oil prices today as likely indicating lower inflation tomorrow (mean reversion/base effects) and as such, changes in energy prices should have little to no effect beyond the first few years of inflation compensation (break-evens) and thus that component of nominal yields. [But] in reality you can often see a clear correlation between energy prices and the entire rates complex.
Olivier Blanchard at the Peterson Institute expounds the standard view that the inflation component of long rates depends mainly on growth, Fed credibility and fiscal sustainability:
The main key is probably a slowing economy. The second key may be removing any uncertainty about Fed independence. The third key is probably deficit reduction.
The recent episode of increases in energy prices suggests that the effects are one-off on inflation. (My paper with Ben [Bernanke]). I suspect the same would hold for energy price decreases, leading to a temporary dip in inflation. The dip in inflation, even temporary, may lead the Fed to be a bit more relaxed about rates. Enough to significantly move the 10-year rate? My guess is no.
Former Treasury secretary Larry Summers emphasises that, from the point of the view of the government, rate policy and deficits should be the focus:
I think the key determinant of inflation is nominal aggregate demand, which depends heavily on fiscal and monetary policy. Treating energy prices as a key issue for longer-term inflation or interest rates would be repeating the policy errors of 2021.
There is, then, a tension between the empirical fact that inflation break-evens seem to track energy prices and the fact that there is no compelling explanation of why this should be so. Bessent goes with the hard fact of the correlation; most other observers seem inclined to follow the economic logic. Whether the years to come provide evidence in favour of either view of course depends on whether energy prices do in fact fall. It is not clear, at least to me, how much control the executive branch has over this.
One good read
FT Unhedged podcast
Can’t get enough of Unhedged? Listen to our new podcast, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on past editions of the newsletter here.
