Essential Economics

— Mark Frears

Nothing, absolutely nothing

As summer is almost officially here, it is boat time. Doesn’t matter if it is a cruise ship or a kayak — there is something about being out on the water.

Following up on last week, there is a link between boats and inflation as well. Given that inflation is the current focus of the Fed, giving them pause, and that the equity markets do not like higher rates and uncertainty from the Fed, we should continue to examine the area of prices.

Is it working?    

Consumer Price Index (CPI) on a year-over-year (YoY) basis was running 8.5% in March 2022. The Fed raised their target Fed Funds rate by 5.25% from March 2022 to July 2023, at the fastest pace ever. Their purpose is to make money less accessible and thereby slow down the economy. CPI YoY has improved to 3.4%, but I would propose that this had less to do with the Fed and more with easing supply chain pressures. 

Consumers

In addition, consumer demand has not slowed materially from the pent up post-pandemic surge. Consumers are definitely noticing their dollar is not going as far, and the categories shown below bear this out.  

Source: Bureuan of Labor Statistics (as of April 2024)

While we have seen very good improvement from the peak prices, there are still significantly higher costs hitting you and me.

Producers

When you look at inflation from the producer’s perspective, they are happy increasing prices, as long as they can control costs, such as labor. As you can see below, while inflation improvement has flattened out, the concern expressed in company’s earnings calls has diminished.

One place they are seeing a rising concern is supply chain. It’s back! The chart below shows the increasing talk of this issue.

Areas of concern

The pandemic supply chain issues caused us to pay attention to an area that, frankly, was taken for granted. Global shipping by water improved after the pandemic, but now, due to wars, China and lower water levels, the concern is rising. As you can see below, there are six identified potential choke points, due to the amount of trade that travels through these.

In each of these areas pointed out above, there are specific risks that have the potential to disrupt normal flows. The chart below shows costs are increasing again on major shipping routes.

Strait of Malacca

This area saw the passage of 23.7% of global seaborne trade volume in 2023. This provides a link between the Indian Ocean and the Pacific, and is the most important single maritime choke point. Oil, natural gas and other commodities pass through on the way to China and Asia’s major countries, while finished goods move in the opposite direction. There are potential issues with pirates, as ships have to slow to make the passage, as well as possible volcanic activity.

Strait of Hormuz

11.1% of world maritime shipping passed through this area in 2023. In prior years when this strait has been restricted, the cost of oil doubled. Its proximity to Iran is probably the biggest risk, and the shallow depth makes mines a viable weapon.

Bab el-Mandeb

You may not have heard the name of this passage, but you have heard about the Red Sea and the Suez Canal recently (see chart below). There has been considerable focus on this area due to the Houthis pirates, and geopolitical ramifications from them. The very real threat here has forced shipping companies to divert all the way around the Southern tip of Africa, increasing costs dramatically. 

Source: American Journal of Transportation

The economy continues to chug right along, driven by consumer spending. Some households are already feeling the impact of inflated prices, and given the elevated risks in critical areas of maritime shipping, this could become a much larger issue.

Economic releases

Last week saw stronger economic data from the ISM surveys and durable goods orders. Also, the consumer sentiment bounced back in the second half of May. Fed talking heads continued the “higher for longer” mantra.

This week’s calendar has consumer confidence, inventories, personal income and spending. Also, we have the PCE metric for April. This is the Fed’s benchmark for inflation. See below for details.