Investment Strategy Brief:
Ships Over Troubled Waters

Below is a transcript of this week’s video.

Hi, this is Mike Reynolds with Investment Strategy at Glenmede. 

Supply chains risks have come into focus over the last few weeks. Iranian-back Houthi rebels out of Yemen have attacked shipping in the Red Sea, particularly around the major chokepoint south of the Arabian Peninsula known as the Bab el-Mandeb. These attacks have prompted a response from the U.S. and its allies, which have intercepted several attacks and attempted to neutralize Houthi military capabilities. This is all an attempt to protect a vital maritime route which is one of three key choke points around the Middle East. 

This has contributed to some incremental stress on supply chains, which relatively recently just got over the snags that contributed to a major worldwide inflation spike. In particular, freight shipping rates have increased considerably. Especially along the Shanghai to Rotterdam route, which typically goes through the Red Sea, the price for shipping a standard 40-foot container has basically quadrupled over the last few weeks. This in part reflects higher insurance premiums and the utilization of costlier routes around the Cape of Good Hope in South Africa. However, this increase pales in comparison to the 14x increase around the post-pandemic economic reopening period, suggesting the disruptions are a bit more localized this time. 

There are some key differences between what we’re seeing now vs. where things stood post-pandemic. In that period, supply chain snags coincided with other contributing factors that were interrelated and had cascading effects on inflation. First of all, there was a dramatic shift in consumer preferences. Households spent much less on services which were generally unavailable (like vacations, concerts, etc.) and instead shifted their spending to goods. This swung goods’ share of household spending up almost 5%. This may not seem like a lot at face value but considering how much of the U.S. economy is based on consumers, this represents several trillion dollars in redirected spending. This occurred alongside (and possibly contributed to), a shortfall in inventories at retail establishments, right when supply chains were at their most vulnerable, worsening inflation to multi-decade highs. 

So what might be the inflation impact this time around? The supply chain disruptions are a bit more localized and don’t appear to imminently threaten global shipping that focuses on other routes. However, one of the transmission mechanisms may be through energy prices. A significant portion of global supply for oil and other petroleum-based products is sourced from the Middle East, so threats to shipping in those channels could have a disproportionate effect on the supply/demand dynamics around energy. This comes at a time when energy is an outright deflationary component of the Consumer Price Index. If that’s a factor that starts to move in the other direction, inflation could prove increasingly sticky. Why does this matter for investors? Well markets have appeared overly optimistic in their expectations for aggressive rate cuts this year, which are predicated on a goldilocks scenario of inflation cooling off with little room for error. Those inflation projections may not properly reflect the risks here. If anything, the recent willingness among firms to shun the lowest cost producers for raw and intermediate goods in favor of more resilient supply chains at home or among allied countries could be a bigger factor fighting inflation. 

So in summary, violence in the Red Sea has compelled the redirection of certain supply chains, diverting them away from the critical Bab al-Mandeb chokepoint. Although shipping rates along traditional routes through the Red Sea have increased significantly, they still remain considerably lower than the levels observed during the pandemic. Supply chain disruptions during the pandemic were more acute, with factors like heightened demand and inventory challenges exacerbating inflation issues. Any consequences stemming from these supply chain disturbances might manifest in energy prices, which have recently played a pivotal role in disinflation. While the impact of the recent events seem contained for now, inflation forecasts may not accurately capture the potential risks or the structurally higher costs associated with building resilience into supply chains. 

Thanks for listening! And please don’t hesitate to reach out with any questions.