Red Sea Update: Inflation Edition

Editors’ Note: MarketMinder doesn’t make individual security recommendations. The below merely represent a broader theme we wish to highlight.

Six months on, Yemen’s Houthi militia continues disrupting trade in the Red Sea, and economic fears linger. Many fret persistent attacks will elevate shipping costs, causing inflation to reheat. While there may indeed be some impact—particularly in the eurozone—several factors likely cushion its degree and duration. Recent business surveys illustrate early evidence of this.

In February, the OECD noted “elevated shipping costs as a result of ongoing tensions in the Red Sea could impede the global fight against inflation,” warning disruption could add around 5 percentage points (ppts) to projected import costs for OECD members in 2024 if disruption persists, with consumers likely footing the bill.^[i] Many fear eurozone inflation may experience outsized upward pressure, perceiving the bloc to be at greater risk of disruption given more of its trade passes through the Suez Canal. There are also fears of mounting output disruption. The UK’s Office for National Statistics highlighted this in January’s monthly GDP estimate, where Monthly Business Survey respondents named Red Sea disruption as a supply chain headwind to growth.^[ii]

While there may be some setbacks, they are likely temporary, limited speedbumps. Yes, when shipping rates spike like they did in November, more often than not, global and eurozone inflation accelerate within a year. IMF data show when global shipping rates experience a shock, which the IMF defines as a one-standard-deviation jump, this can cause global inflation to accelerate by 0.6 ppt in a year’s time.^[iii] (Exhibit 1) By the same math, a shock in shipping rates can cause eurozone inflation to accelerate a skosh more—0.7 ppt. (Exhibit 2) Plus, global supply chain stress has been building, adding to inflationary pressures. (Exhibit 3)

However, with shipping prices down over -25% already as firms adapt to alternate trade routes, inflation—both globally and in the eurozone—doesn’t seem likely to reaccelerate materially or stay hotter. The Baltimore bridge collapse compounds fears right now, but the industry is already adapting. Importantly, fleeting spikes have little long-term impact. Since 1987, of the five instances where shipping prices spiked but started falling within a year, global inflation accelerated 12 months later in only one instance—2009 (Exhibit 1).

However, this had far more to do with commodity prices collapsing amid the global financial crisis after skyrocketing in 2008. This, combined with a sharp monetary contraction, brought deflation in September 2009, but inflation returned as the economy recovered. In the eurozone, of the same 5 instances, inflation accelerated 12 months later only twice—in 1991 and 2009. (Exhibit 2) Moreover, most expect the global container vessel fleet to grow 10% this year, adding 3.1 million twenty-foot equivalent units of capacity.^[iv] This should partially offset the capacity loss from diverting around a 10 – 14 day longer route via the Cape of Good Hope.

Plus, firms now have better supply chain-management buffers than before the pandemic, making them more resilient to supply disruption, limiting any impact’s duration. For example, Abercrombie & Fitch noted it would seek out using “air freight where possible,” noting “shipping disruptions have reminded the company of how interconnected the global shipping industry is and that they shift transportation modes and shipping lanes when warranted to maintain the flow of goods.”^[v] This helps explain why many firms have said that aside from temporary delays, they don’t expect significant impacts to their businesses or prices. Zara parent company Inditex, which relies on Europe for ~60% of its sales, noted its “operations have not been significantly impacted by this situation so far,” highlighting in its recent earnings call that despite the crisis, January supply chain conditions actually normalized relative to the year prior.^[vi] That said, not all firms echo this sentiment. Tesla suspended most car production at its factory near Berlin for two weeks in January and February due to a lack of components caused by shifts in transport routes.^[vii] But broadly, companies are adapting.

Recent surveys back this up. March eurozone flash PMI data showed that, despite continued disruption, delivery times for eurozone manufacturers declined, while input prices for factories continued falling.^[viii] Additionally, February eurozone and UK business equipment surveys conducted by the European Commission and CBI, respectively, showed the share of manufacturing firms reporting equipment and input shortages continue falling sharply—as they have done since 2022—apparently undeterred by longer travel times.^[ix]

Ultimately, despite continued attacks, delivery times and shipping prices are already improving and look likely to go better than feared. Reality proving fears false is one big force propelling stocks during bull markets, and this should be a modest contributor.

Exhibit 1: Global CPI Increases 0.6 Percentage Points on Average When Shipping Rates Spike

Source: FactSet & IMF, as of 3/25/2024. IMF defines “spike” as a 21.8 percentage point increase in global shipping costs. Baltic Dry Index used as a proxy for shipping rates, monthly, 1/1/1987 – 2/29/2024. Global CPI is GDP-weighted with all MSCI ACWI Countries (ex. Brazil & Argentina due to elevated M2), 1/1/1987 – 12/31/2023. Hat Tip to Fisher Investments Research Specialist Bobby Sirois.

Exhibit 2: Eurozone CPI Increases 0.7 Percentage Points on Average When Shipping Rates Spike

Source: FactSet & IMF, as of 3/25/2024. IMF defines “spike” as a 21.8 percentage point increase in global shipping costs. Baltic Dry Index—used as a proxy for shipping rates—and eurozone CPI, monthly, 1/1/1987 – 2/29/2024. Hat Tip to Fisher Investments Research Specialist Bobby Sirois.

Exhibit 3: Supply Chain Pressure Leads Global CPI by 6 Months

Source: Federal Reserve Bank of New York and FactSet, as of 3/25/2024. Global Supply Chain Pressure Index (GSCPI), 1/1/1998 – 2/29/2024. CPI is GDP-Weighted with all MSCI ACWI Countries (excluding Brazil & Argentina due to elevated M2), 1/1/1998 – 12/31/2023.