The Houthi Shipping Attacks and Their Economic Implications
January 23, 2024
Shipping researcher J Mintzmyer of Value Investor’s Edge joins macro team head, Kate Dunbar, to discuss the recent attacks on commercial ships in the Red Sea and the impact of these attacks on global trade and inflation.
Since November of last year, the Yemen-based Houthis have conducted missile and drone strikes on commercial ships in the Red Sea as part of an escalation in regional tensions in the wake of the Israel-Hamas war. The attacks have created significant disruptions, forcing ships to use less-efficient alternative routes, straining supply chains, and driving a significant increase in global shipping costs. And this turmoil risks putting upward pressure on global inflation.
To discuss these attacks in more detail and what they mean for the economy and investors, macro team head, Kate Dunbar, and deputy editor of the Daily Observations, Jake Davidson, sat down for a conversation with shipping researcher J Mintzmyer. J founded the research platform Value Investor's Edge, which focuses on maritime shipping and provides research on publicly traded shipping and energy firms.
In this discussion, we cover a variety of dynamics related to the Red Sea crisis, including how shipping companies are handling the attacks; which regions and goods are most impacted by the disruption; how the US, its allies, and China have responded; and how these supply chain pressures fit into the broader global inflation picture. We hope you enjoy the conversation.
Editor’s note: the views of external guests do not necessarily reflect the views of Bridgewater.
TRANSCRIPT
Note: This transcript has been edited for readability.
“So already, as of now—and this is not every single container ship diverting, this is more than half, about two-thirds of the volume is diverting—we’ve already seen shipping rates go up between 2x and 3x. So a 100% to 200% increase depending on the routes. But these ships are mostly interchangeable between different routes. So even though it only impacts one major route, which is Asia to Europe, it’s impacting the globalized market price of these rates. So they went up—they’ve doubled to tripled as of now.”—J Mintzmyer, founder of Value Investor’s Edge
Jake Davidson
I’m Jake Davidson, deputy editor of the Daily Observations.
Since November of last year, the Yemen-based Houthis have conducted missile and drone strikes on commercial ships in the Red Sea in a series of attacks as part of an escalation in regional tensions in the wake of the Israel-Hamas conflict. The attacks have created significant disruptions, forcing ships to use less-efficient alternative routes, straining supply chains, and driving a significant increase in global shipping costs. And all of this turmoil risks putting upward pressure on global inflation.
To discuss these attacks in more detail and what they mean for the economy and investors, I recently sat down for a conversation with macro team head, Kate Dunbar, and shipping researcher J Mintzmyer. J founded the research platform Value Investor’s Edge in 2015, which focuses on maritime shipping and provides research on publicly traded shipping and energy firms. Listeners may remember that last year we published a different conversation with J where we discussed the state of global shipping and how it connects to nearly every part of the global economy and many of the big macro issues we watch.
In this discussion, we cover a variety of dynamics related to the crisis in the Red Sea, including how shipping companies are handling the attacks; which regions and goods are most impacted by the disruption; and how the US, its allies, and China have responded. We also cover the forward-looking picture for global shipping and how these supply chain pressures fit into the broader global inflation picture. So with that, let’s get right into the conversation.
Chapter 1: Overview of Attacks
All right, J, Kate, thank you so much for joining me. Kate, great to have you back. And J, also, great to have you back. Thank you so much for joining the podcast again.
J Mintzmyer
Thanks, Jake, for inviting me back for this as well. Great meeting you, Kate—sharing the mic with you a little bit.
Kate Dunbar
Great to meet you, J. I’m looking forward to this conversation.
Jake Davidson
J, I think what we’re going to do is start with you and really get into what’s going on with shipping. And then we’ll go to Kate and discuss the macro implications.
So, starting with you, I think many of our listeners have seen the headlines around the attacks on ships by the Houthis in the Red Sea or read some of the coverage. But it would be great if you could just start by giving a high-level overview of what’s going on and putting these attacks in the context also of other developments you’ve seen in the shipping industry over the past year or so.
J Mintzmyer
Certainly. We’ll zoom back a little bit to last fall. In the situation last fall, we had a pretty fairly tight situation in both tanker traffic—think crude oil, refined products, gasoline, diesel. Container shipping was recovering from the crisis that we had in 2020-21, into ’22. But the tankers were pretty tight and dry-bulk markets were also fairly tight.
Well, last fall, the Panama Canal situation started to worsen because they’d had an ongoing drought in that region for the last year or so. The Panama Canal depends on the levels of a lake called Lake Gatun—it’s in that region—and every time those locks, those little containers, are filled up to let the ships go through, that requires pulling water away from the lake. So that drought situation had worsened throughout last summer and last fall. And starting last fall, the Panama Canal Authority had to limit the amount of transits through the canal.
So you had an already fairly tight market in tankers, in bulkers, and a transitioning market in containers. So that Panama Canal situation started to worsen those markets and that was happening in October, November, December of last year.
Then of course we had the issues in Gaza, which have escalated right across the region. The Houthis decided to show their solidarity with the folks in Gaza by doing indiscriminate attacks on ships around the Red Sea. That took an already-tight market and threw it into further chaos.
So just to give a big-picture background on why that’s important: 15% of the global trade goes through that Suez Canal region, through the Red Sea, and there’s a little choke point called the Bab el-Mandeb, which is across—you have Somalia on one side, which I’m sure most folks have been familiar with in the past because of the piracy concerns in that area; and on the other side, you have the southwestern area of Yemen, which is where the Houthis have their stronghold. So not only is it 15% of global trade; it’s actually about 30%—nearly one-third—of global containerized trade. Think retail goods—those 20-foot, 40-foot boxes. About 30% of that global trade, mostly between Asia and Europe, is going through that choke point.
With the Houthis indiscriminately attacking vessels—and it was unanswered for several weeks, and so a lot of the more risk-averse shipowners, especially the container-shipping owners, decided to reroute a lot of their traffic south around Africa. And so that adds 50%. But just high-level point, why this is important is because you have an already fairly tight market, and now you’re taking 30%—so almost a third of the container trade—and you’re adding 50% to the voyage distance around Africa when those ships reroute.
If you think about a supply-and-demand market, shipping demand is measured at ton-miles—so the amount of cargo and how far it’s moving. If you take 30% containerized trade, and you add 50% to that, that’s a 15% boost almost overnight to the demand measured in ton-miles. So if your market is fairly tight, you’re going to see rates go ballistic. And that’s what we’ve seen. We’ve seen containerized trade rates go up between 2x and 3x just over the last month. And we’ve also seen tanker rates tightening a little bit more as well.
Jake Davidson
I want to get into what that response has been and how those prices have moved. But before we move on, could you just provide some additional context on the specifics of these attacks, just to get a sense of the severity? You mentioned Somali piracy—maybe that’s a good comparison to start with.
J Mintzmyer
Yes. It’s a great question. Somali piracy—that peaked, I would say, five or six years ago. Those were mostly little speedboats: you’d have an armed crew of three to five people on a speedboat, and they’d approach the ships and try to board them, try to hijack them. Once the shipowners started to hire armed guards and there was a little bit more of a heightened naval presence there—once those reactionary measures were imposed, the piracy threat kind of fell off the radar.
But the Houthis are doing their attacks in three prongs. They’re using these unarmed suicide drones; they’re using surface-to-sea ballistic missiles; and they’re also doing the speedboat-hijacking-type tactics. So they’re coming at this in three different waves. So far, thankfully, no crew members have died. No ships have been sunk. So it’s mostly just an emerging threat.
Chapter 2: Response of Shipping Companies
Jake Davidson
Given the severity of these attacks and the increased risk, how have shipping companies responded?
J Mintzmyer
If you think about the risk adversity of a lot of these shipowners, an average container ship now—they’ve gotten much larger over time. So a lot of these ships have 10,000, 12,000, 15,000 units of cargo on these vessels. We’re talking total cargo volumes and value of maybe $2, $3, $4 billion per ship. So the amount of potential damages—even if it’s just a partial loss of the ship, let alone a total loss—you’re thinking about the lives of 15 or 20 crew members; you’re thinking about $2 or $3 billion of cargo. And so the risk calculus, even if it’s just a fraction of a percent, really, really pushes these shipowners to decide to reroute their vessels. And that’s why we’ve seen container ships do that.
We haven’t seen the same coordination on the tanker side because the tanker cargoes are closer to $50, $60, $80 million, which is still a big amount, but it’s an order of magnitude lower than it is for container ships. And the other factor there is, the container-shipping fleet is very consolidated—it’s an oligopoly. The top three or four owners control like half the market. So it’s a lot easier for those shipowners to come together and—in the interest of safety, they can come together and decide we’re not going to go through this, we’re not going to take this risk. And in a normal market, that might be considered collusion—anticompetitive practices. But when it’s a matter of safety, loss of life, loss of massive cargo values, it’s a little bit different.
The tanker markets are far more fragmented. You have hundreds of different owners and traders moving through that region. So we haven’t seen the same risk adversity in the tanker owners yet. I think that’s why you’ve seen the tanker rates—they’re strong. The market’s already tight. You’ve seen the tanker rates inch up, I’d say, 20%, 30%, 40% on average. But you haven’t seen that same 2x or 3x impact. And that’s mostly because the tanker owners until very recently had not started diverting around.
Jake Davidson
You mentioned ships being diverted through these less-efficient routes. Can you just speak to how these alternative routes compare to the normal ones, in terms of the added time and distance?
J Mintzmyer
It depends of course. There are lots of different sources from Asia, and there are lots of different final destinations in Europe. But one of the most popular routes is China to Rotterdam, which is the Netherlands—that controls a lot of the volumes there. So the container ship would leave the Asian region, and it would go around India and the Middle East, and it would go through the Red Sea, through the Suez Canal, through the Mediterranean Sea, and the stuff that’s going to Southern Europe would then dock in the Southern European ports.
The stuff that’s going to Northern Europe, which is actually the majority of it, would then go through the Strait of Gibraltar, which is south of Spain. It would go around over there by the UK, and it would dock in Rotterdam. So that’s the normal route. Again, it depends on the exact destinations and the partial locations, but you’re talking about a voyage of 40 days, 45 days, somewhere in there—maybe 50, if they’re slow steaming or there are canal delays or things like that.
Now, if that same vessel that we just talked about, that same route, now they’re going south of Africa, and going all the way around, it adds anywhere from 15 to 20 days to that voyage. And so, roughly rounding, that’s where you get the 50% increase in voyage length.
Jake Davidson
So let’s connect this to the prices specifically. How does the significant increase in the voyage length impact shipping prices?
J Mintzmyer
So already, as of now—and this is not every single container ship diverting, this is more than half, about two-thirds of the volume is diverting—we’ve already seen shipping rates go up between 2x and 3x. So a 100% to 200% increase depending on the routes. But these ships are mostly interchangeable between different routes. So even though it only impacts one major route, which is Asia to Europe, it’s impacting the globalized market price of these rates. So they went up—they’ve doubled to tripled as of now.
Jake Davidson
Another part of that rise in shipping rates I want to ask you about is the rise in insurance costs. Can you just talk through a little bit how that cost increase is contributing to the shipping price pressures?
J Mintzmyer
That’s a good question as well. There are two reasons. One of them is just general risk adversity. You’re not wanting to put your crew members at risk. You’re not wanting to take that element. But the economic side of things is the changes in war risk premium for vessels that are transiting the Red Sea route. Normally the war risk premium is a fraction of a percent. It’s maybe a few thousand dollars per voyage. It’s not necessarily a huge deal. That war risk premium has moved up into the single percent digits—so maybe 1%, 2%. That’s a 100-fold increase in the cost of insurance. If you’re talking about a 1% or 2% war risk insurance cost on a cargo worth $1 billion, that’s a massive amount of money. And so I think that’s the economic impetus behind why a lot of these container vessels are diverting.
When you look at some of the other vessels like tankers and bulkers, a lot of the crew members of these vessels are either outright refusing to participate in voyages that go through that region or they’re demanding a double or triple hazard pay. So that’s another needle mover on the economic side.
Kate Dunbar
J, can I just jump in here for a second? Could you take a second to talk through who’s paying those spot prices? As for the flow-through to inflation, what’s going to matter is the combination of who’s actually facing those price increases—so the 100-200% that you mentioned in the spot—versus how many of the companies are paying on much longer-term contracts.
J Mintzmyer
Certainly, Kate. It’s a great question. The majority of large-scale traffic is done under these longer-term contracts. These are typically—they’re one-year contracts, and they’re normally negotiated between about February and April of each year, and they’re normally signed in April or May. And so this year, there have already been rumblings or rumors that those contracts are going to be signed closer to May or June. I think a lot of customers are taking a wait-and-see approach to see if the air strikes and the other actions are going to stabilize the region a little bit more. So that negotiating period has been moved back a little bit, extended a little bit.
But if we fast-forward to April and May, and we’re in the same position we are today—if everything’s just kind of status quo—then we’ll see those contract rates roll up significantly, and then you’ll probably see contract rates double or triple for the following year. You’re absolutely right, Kate. That’s the point in time—again, April, May, June of 2024—that’s the point in time when we can follow up and say, OK, this is really going to have a major impact for the holiday season. This is going to have a major impact on big companies like Amazon, Walmart, Costco—those major importers.
As of now, it’s mostly the spot buyers—the just-in-time people—who are paying most of these impacts. It hasn’t really broken too many markets. The only markets we’ve seen that have broken are the last-minute, very-high-value items. We’ve seen some automobile chips—automobile chips have been in shortage for the last several years, so this is just continuing that issue. But there were some news reports about Tesla wasn’t able to get enough of their chips through and things like that. Those very-high-value items can normally be diverted to air cargo. Now, air cargo costs about 10 times as much as maritime cargo, sometimes 20 times as much. But if you’re talking about things like iPhones, or chips, electronic chips for vehicles, those are very value-dense items. So you could probably pay 10x or 20x more, and it would only be a few hundred dollars more for the final vehicle, the final product. If you’re talking about a $70,000 vehicle, a couple of hundred dollars more is not going to make or break anything.
Jake Davidson
You’ve alluded to this throughout the conversation a little bit, but can you just walk through more specifically which goods have been most impacted by these disruptions?
J Mintzmyer
Yes. It’s primarily retail goods—so anything that would go into a containerized box, in these 20-foot to 40-foot boxes, the kind of stuff you see on a railroad car or on a truck. So anything you’d buy at Target, Walmart, Amazon—those sorts of goods are the most impacted by this. Again, keep in mind, it’s not just the Asia-to-Europe trades; it’s impacting even China to the US, going into LA and Long Beach, because any time the global price moves, the demand increases for this sort of traffic, this sort of vessel, it’s going to impact worldwide markets. So it’s basically going to hit all sorts of retail goods.
It’s similar to the impact—not as large but is similar in theory—to the impact that we had back in 2021 when we had the supply-chain crisis, and people were talking about Christmas being canceled. This one is not going to necessarily impact availability on store shelves because we do have decent capacity available. We’re not seeing port congestion, at least not yet. There are probably not going to be shortages on shelves, but the cost of goods—because shipping is an important cost whenever we have these global trades—that cost is certainly going to rise. And during the supply-chain crisis, we saw shipping rates go up by 10x, and so far we’re roughly 2-3x. So we’re not at the magnitude that we saw in 2021, but we’re certainly moving in that direction.
Chapter 3: Forward-Looking Picture
Jake Davidson
All right. So, J, you’ve described how things are up through now in terms of what’s going on, what the disruptions are. How are you seeing the impact of this issue and the trajectory of this issue going forward?
J Mintzmyer
Well, every time we look, every other day, there are different strains of news flow. And just to talk you quickly through what we’ve seen so far: the diversions started in the middle of December, and Maersk, in particular, but also CMA CGM—which is a French company, a very large liner company—MSC, which is based in the Mediterranean. Those three companies—Maersk, MSC, and CMA CGM—were lobbying heavily for protection, some sort of military convoy or military guarantees, and the US did respond. It’s called Operation Prosperity Guardian, and they launched that around Christmastime.
In response to that, around Christmas Eve, Maersk announced that they were going to continue—they were going to bring their vessels back and try to work them through the Red Sea and the Suez Canal. But even after the US assembled a small coalition to go protect that area, the attacks continued. In fact, the attacks actually increased during that period of time between Christmas and right after New Year’s.
So then the US very recently, as you’ve seen on the news, launched selective air strikes into Yemen. And that was a warning. They didn’t really target personnel. In fact, they choreographed the attacks very clearly. We saw the leak that came out of the UK. The prime minister was going to go talk to his cabinet, and it was leaked that the UK was going to participate in strikes immediately. That was probably deliberate because this was meant to be a choreographed warning strike.
But the Houthis responded right after that with more attacks on vessels. They said they weren’t going to stop. And so now we’ve seen this tit for tat, where every time the Houthis attack a couple of vessels, the US and the UK and that coalition strike a few more targets in Yemen. And it’s been going back and forth now for a little bit more than two weeks. It doesn’t seem—I wouldn’t say it’s necessarily worsening. The volume of attacks is about the same, maybe slightly less. The impact of those attacks is about the same. There’s slight vessel damage; there are concerns, but there hasn’t been any loss of life, there hasn’t been any vessel sinking, thankfully.
But now it’s sort of a status quo of a tit-for-tat back and forth. The Houthis will attack vessels, the US will selectively strike a couple targets, and the shipping companies continue to mostly divert. The one thing that did change about a week ago, closer to 10 days as we’re recording—we’re talking on the 23rd of January 2024—about 10 days ago, several large tanker owners, most of the ones that were controlled from the EU—a Norwegian company, some Greek companies—they also publicly announced that they were going to avoid that region. So it’s escalated beyond just container traffic, and now it’s impacting tanker rates.
As I mentioned earlier, tanker rates are up 20-30%, so it’s not the 2-3x movement. But just those handful of companies that are now diverting has already moved rates up by 20-30%.
Chapter 4: Cross-Cutting Pressures
Jake Davidson
I want to ask two last questions to wrap up on shipping, and then let’s move to Kate.
The first is, you’ve described this particular pressure on shipping very clearly, but it’s just one pressure. When you zoom out and look at all of the cross-cutting dynamics affecting shipping—the Houthi strikes, but also supply/demand, some of the ESG considerations you mentioned in our previous podcast—how would you net all of these pressures in terms of their impact on shipping prices right now? And are some of these other dynamics lessening or worsening the impact of the strikes in the Red Sea?
J Mintzmyer
Well, it’s certainly worth seeing the problem in all markets, and especially in tankers. Because the interesting thing about the tanker market is the supply-and-demand balance is already extremely tight. There’s not any additional capacity available. And part of that is due to pressures we’ve talked about in previous discussions. The global tanker fleet is the oldest it’s ever been. The order book is one of the smallest it’s ever been, so there’s not a lot of new capacity coming online. There are a lot of new environmental regulations that started last year and will continue to escalate throughout the next five years, which will push older capacity offline. They also had the Russian invasion of Ukraine and the subsequent sanctions on Russian oil and product exports. So you already had this very tight market. So the tanker rates—they’ve only moved 20%, 30%, maybe 40% as of now. But if there’s a total shutdown or a total diversion of tanker rates, those could go ballistic really quickly.
The container market, as I mentioned, it’s moved to 2-3x. And the container market I would say is bordering on oversupplied at this point. So even with an oversupplied container market—and I say oversupplied assuming everything’s working, everything’s functioning normally. But even with that oversupplied market, we’ve seen rates go 2-3x because containers are almost 100% avoiding that region right now.
If tankers go from partially avoiding to fully avoiding, we could definitely see those rates move up, and that will impact consumers directly in terms of gasoline prices; will impact manufacturing industrial bases in terms of crude oil prices; and all those sorts of things. You might not see the global price of crude oil move because that’s just traded on international benchmarks. But the actual landed price, what the actual consumers and gas stations and refineries and such are paying, those prices will move up.
Chapter 5: Impact of Higher Geopolitical Risk on Global Trade
Jake Davidson
And then, last question, J, just to really step back. We’re in a world of what seems to be secularly higher geopolitical risks and a more multipolar world where the Pax Americana, underwritten by the US and its allies, is being increasingly challenged. Do you see this kind of disruption to global trade as becoming more common going forward as a result? Or does this look more like a blip than the start of a trend?
J Mintzmyer
I’m just going to speak academically at this point—not an official policy position or anything like that. But just looking big picture, any time we shift from a unipolar world, where the US—you called it Pax Americana—the US is controlling everything, into a multipolar world, where you have the major emergence of China, India is now a major player in that region—any time you have that sort of situation, and you have a threat from someone like the Houthis, or you have this crisis in Gaza, you have to have a coalition that assembles the actual key players, real players. Your coalition right now in Operation Prosperity Guardian is the United States and the UK. Then you have the French, who aren’t participating directly in the operation, but they have sent some naval assets. And that’s great. That’s the response they need to take.
But if they want to completely make the area safe, or solve the problem, they have to include the players that actually matter, including China, including India, including some of those more, I would say, more relevant maritime players in that region. Because if you look at China: China is the number one most dominant maritime exporter in terms of containerized finished goods. They’re also the number one importer in terms of commodities in dry bulks, in liquid cargoes. So they’re the most major player; they’re the ones with the most at stake here. So if you want to fix this situation, it has to be a joint effort with those partners that matter in terms of economic trade.
We haven’t seen that. Even with Operation Prosperity Guardian, there hasn’t been a lot of buy-in, even from the Western nations. In fact, the UK was the only country that joined with the air strikes in Yemen. I believe there’s a list of 9 or 10 countries that are supporting the operation, but they’re not supporting it directly with assets on the water. They’re just supporting it in principle.
Jake Davidson
Just a quick follow-up because that’s an interesting point. Given the significant impact that these attacks have had on China’s trade routes, could you say a little bit more on how China has responded?
J Mintzmyer
They’ve deployed a few assets over to that region, but they haven’t participated in any counterstrikes or defensive actions. The Chinese have a naval outpost—it’s not quite a full-up naval base—but they do have a naval presence in Djibouti, which is over there by Somalia on the western side of that choke point. So China certainly has the capacity to take action here. And I don’t know for sure, but I would imagine there are back-channel things going on.
But China’s particular interest is mostly on the other side of Yemen, which would be the Strait of Hormuz. That’s where most of the Middle Eastern oil exports flow out of. So that’s where if that strait became endangered—because Iran has threatened throughout the decades—I mean, this is nothing new. But every time tensions inflame, one of Iran’s threats is that they’re going to shut down the Strait of Hormuz. I think that would be the point at which China would become very involved and very interested.
At this point with the containerized trade, it’s certainly hurting China a little bit, but they’re able to have their goods be diverted around. Shipping costs in most goods maybe are 1% or 2% of the total cost of the good. So even when we say they’ve tripled, they’ve gone from 1% or 2% to 3-6%. So it’s not that magnitude of impact where China’s going to want to commit military resources. China’s always had this sort of policy, at least in the last 20 years, where they like to play or pretend like they’re a neutral participant or they’re a neutral observer. They don’t like to pick sides on these sorts of things. So far, China’s just continuing that status quo.
Chapter 6: How Supply Chain Disruptions Flow Through to Inflation
Jake Davidson
All right, Kate, I want to turn to you now. As macro investors, the major way this topic matters for us is how the supply chain disruptions flow through to inflation. You wrote a Daily Observations recently on our inflation outlook, which touched on this topic. How are you seeing the inflationary impact of the shipping disruptions so far?
Kate Dunbar
So as J mentioned, shipping is one of the pieces of the costs for a good. But you have a lot of other sources of the costs. And you have businesses making choices about just how much they want to handle those increases in costs themselves or push them onto consumers. And so, in total, transportation accounts for between 1% and 2% of the final cost for a good. Most of the shipping costs that we’re talking about are negotiated over longer-term contracts.
So where we are now is, even though you’ve had these disruptions going on for approaching a month now, you’re not seeing that yet start to pass through to the prices facing consumers. And we wouldn’t expect to see that pass through to consumers for a while, unless this thing is sustained for some time, as it doesn’t change the end price for most of the goods that you would be receiving from big-box stores. So that’s one piece.
Then I would say, I think it is easy to hear about shipping disruptions and draw the parallels to COVID. And it’s important to draw a little bit of a distinction between what was happening in the COVID period and what’s happening now. The first thing is, as J already mentioned, there’s a difference in the order of magnitude to date of the moves in the prices—something like 10x increases in the worst of the COVID period and more like 2-3x today.
But you also had things like a huge surge in the demand for goods happening at the same time. And so people really wanted to get their hands on goods as much as they could. And businesses were able to pass those costs on because they were facing that wall of demand and consumers that were willing to pay.
Then, finally, you had complicating the shipping disruptions a series of labor disruptions that meant that at every stage of the supply chain, it was hard to get people to move the goods. So even if the ships reached ports, you struggled to unload them, and that created increasing problems; and then struggled to get them over the ground to where they needed to go.
So all of those things happening at the same time were a key part of the huge surge and subsequent normalization in goods inflation. Right now, we’re really only experiencing a disruption to one piece of that. The demand for goods has slowed a lot, and even with growth moving along at a healthy pace today, a lot more of that growth is in services. You just have less of that kind of clogged-up picture of people needing to get goods.
You also have inventories in a much healthier place than where they were, as companies experienced the drawdown in those inventories and seek to build them back up. So you have a little bit of buffer in that way. The labor disruptions are much less of an issue today. So when you look at that, you have a much healthier supply chain than what we had during COVID. And so the impacts of this are likely to be, for now, much smaller and are happening in an environment that is a little bit less broadly inflationary.
With that said, this is a marginal upward pressure, and so it could quite easily flow through to seeing a little bit more goods inflation. It will likely flow through to places where the shortages still haven’t fully normalized in the post-pandemic period, autos being one of the real places that we’ll be watching to see just how big a deal this ends up being.
And there will be some regional differences. While the overall impact on shipping prices should be similar globally, the risk of shortages is most acute in Europe. Europe is an area that’ll be much more exposed to the particular routes where prices are rising. So we’d expect to see a little bit more of an impact on Europe than, say, the US; though shipping and global goods trade are very correlated, so there will be some impact.
So overall, it’s largely, for now, something we are tracking as likely to be a marginal upward pressure, but not something that is likely to be a repeat of the same kind of experience we had coming out of the pandemic.
Chapter 7: Fitting This Disruption into the Broader Inflation Picture
Jake Davidson
How does this disruption fit into the broader inflation picture, particularly given the complexion of the inflation pressures across goods and services, and how goods in particular has contributed to some of the disinflation we’ve been seeing recently?
Kate Dunbar
I think it’s helpful to go back a couple of months and tell the story a bit of how we got to where inflation is today. We talked a bit about goods coming out of the pandemic—huge surge in goods inflation and then as things normalized, you started to see goods inflation fall. It’s running flat in the US now. You even saw a little bit of deflation. At the same time, you had services inflation rise with a bit of a lag to goods, but rise pretty much everywhere. And then it has softened some, particularly as some of the most acute labor shortages have cleared. But it’s still running at levels that are well above central bank targets. Finally, you’ve had what’s been going on in housing inflation, which—pretty lagged but high and staying roughly where it is.
Over the last print or two in the data, you’ve seen the pace of declines in inflation slow some, mostly as the falling in goods prices has slowed, and some of that services data has still held up. When we look forward at the pressures on inflation over the next year, we expect to see a little bit more continued normalization—so inflation falling and getting close to 2%, but not quite there yet. That’s a reflection of a combination of housing continuing to normalize as a lot of the pressures that led to the disruptions there mostly normalize and that data reporting catches up to what’s actually going on in the rental market and to the softer demand there.
And then we’d expect to see services remain pretty hot absent something like declining wage growth. So you might get a little bit softer services prints as wages normalize a bit, but likely to stay roughly where they are. And then the broad-based pressures on goods are consistent with more continued weakness, with this pressure being the main thing that cuts in the other direction.
So against the shipping disruptions, you’ve had the things like the big declines in commodity prices that will flow through to lower costs for the materials that the goods are made of. At the same time, you still have the demand rotating, and so less demand for goods, many of the other sources of cost coming down, and so still mostly disinflationary. But that could change. And this disruption is one of the key ways that could change and could alter that forward-looking view.
Jake Davidson
J, Kate, thank you so much for joining me and sharing your thoughts. And J, thank you for coming back on the podcast. I look forward to talking with both of you again real soon.
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Since November of last year, the Yemen-based Houthis have conducted missile and drone strikes on commercial ships in the Red Sea as part of an escalation in regional tensions in the wake of the Israel-Hamas war. The attacks have created significant disruptions, forcing ships to use less-efficient alternative routes, straining supply chains, and driving a significant increase in global shipping costs. And this turmoil risks putting upward pressure on global inflation.
To discuss these attacks in more detail and what they mean for the economy and investors, macro team head, Kate Dunbar, and deputy editor of the Daily Observations, Jake Davidson, sat down for a conversation with shipping researcher J Mintzmyer. J founded the research platform Value Investor's Edge, which focuses on maritime shipping and provides research on publicly traded shipping and energy firms.
In this discussion, we cover a variety of dynamics related to the Red Sea crisis, including how shipping companies are handling the attacks; which regions and goods are most impacted by the disruption; how the US, its allies, and China have responded; and how these supply chain pressures fit into the broader global inflation picture. We hope you enjoy the conversation.
Editor’s note: the views of external guests do not necessarily reflect the views of Bridgewater.
TRANSCRIPT
Note: This transcript has been edited for readability.
“So already, as of now—and this is not every single container ship diverting, this is more than half, about two-thirds of the volume is diverting—we’ve already seen shipping rates go up between 2x and 3x. So a 100% to 200% increase depending on the routes. But these ships are mostly interchangeable between different routes. So even though it only impacts one major route, which is Asia to Europe, it’s impacting the globalized market price of these rates. So they went up—they’ve doubled to tripled as of now.”—J Mintzmyer, founder of Value Investor’s Edge
Jake Davidson
I’m Jake Davidson, deputy editor of the Daily Observations.
Since November of last year, the Yemen-based Houthis have conducted missile and drone strikes on commercial ships in the Red Sea in a series of attacks as part of an escalation in regional tensions in the wake of the Israel-Hamas conflict. The attacks have created significant disruptions, forcing ships to use less-efficient alternative routes, straining supply chains, and driving a significant increase in global shipping costs. And all of this turmoil risks putting upward pressure on global inflation.
To discuss these attacks in more detail and what they mean for the economy and investors, I recently sat down for a conversation with macro team head, Kate Dunbar, and shipping researcher J Mintzmyer. J founded the research platform Value Investor’s Edge in 2015, which focuses on maritime shipping and provides research on publicly traded shipping and energy firms. Listeners may remember that last year we published a different conversation with J where we discussed the state of global shipping and how it connects to nearly every part of the global economy and many of the big macro issues we watch.
In this discussion, we cover a variety of dynamics related to the crisis in the Red Sea, including how shipping companies are handling the attacks; which regions and goods are most impacted by the disruption; and how the US, its allies, and China have responded. We also cover the forward-looking picture for global shipping and how these supply chain pressures fit into the broader global inflation picture. So with that, let’s get right into the conversation.
Chapter 1: Overview of Attacks
All right, J, Kate, thank you so much for joining me. Kate, great to have you back. And J, also, great to have you back. Thank you so much for joining the podcast again.
J Mintzmyer
Thanks, Jake, for inviting me back for this as well. Great meeting you, Kate—sharing the mic with you a little bit.
Kate Dunbar
Great to meet you, J. I’m looking forward to this conversation.
Jake Davidson
J, I think what we’re going to do is start with you and really get into what’s going on with shipping. And then we’ll go to Kate and discuss the macro implications.
So, starting with you, I think many of our listeners have seen the headlines around the attacks on ships by the Houthis in the Red Sea or read some of the coverage. But it would be great if you could just start by giving a high-level overview of what’s going on and putting these attacks in the context also of other developments you’ve seen in the shipping industry over the past year or so.
J Mintzmyer
Certainly. We’ll zoom back a little bit to last fall. In the situation last fall, we had a pretty fairly tight situation in both tanker traffic—think crude oil, refined products, gasoline, diesel. Container shipping was recovering from the crisis that we had in 2020-21, into ’22. But the tankers were pretty tight and dry-bulk markets were also fairly tight.
Well, last fall, the Panama Canal situation started to worsen because they’d had an ongoing drought in that region for the last year or so. The Panama Canal depends on the levels of a lake called Lake Gatun—it’s in that region—and every time those locks, those little containers, are filled up to let the ships go through, that requires pulling water away from the lake. So that drought situation had worsened throughout last summer and last fall. And starting last fall, the Panama Canal Authority had to limit the amount of transits through the canal.
So you had an already fairly tight market in tankers, in bulkers, and a transitioning market in containers. So that Panama Canal situation started to worsen those markets and that was happening in October, November, December of last year.
Then of course we had the issues in Gaza, which have escalated right across the region. The Houthis decided to show their solidarity with the folks in Gaza by doing indiscriminate attacks on ships around the Red Sea. That took an already-tight market and threw it into further chaos.
So just to give a big-picture background on why that’s important: 15% of the global trade goes through that Suez Canal region, through the Red Sea, and there’s a little choke point called the Bab el-Mandeb, which is across—you have Somalia on one side, which I’m sure most folks have been familiar with in the past because of the piracy concerns in that area; and on the other side, you have the southwestern area of Yemen, which is where the Houthis have their stronghold. So not only is it 15% of global trade; it’s actually about 30%—nearly one-third—of global containerized trade. Think retail goods—those 20-foot, 40-foot boxes. About 30% of that global trade, mostly between Asia and Europe, is going through that choke point.
With the Houthis indiscriminately attacking vessels—and it was unanswered for several weeks, and so a lot of the more risk-averse shipowners, especially the container-shipping owners, decided to reroute a lot of their traffic south around Africa. And so that adds 50%. But just high-level point, why this is important is because you have an already fairly tight market, and now you’re taking 30%—so almost a third of the container trade—and you’re adding 50% to the voyage distance around Africa when those ships reroute.
If you think about a supply-and-demand market, shipping demand is measured at ton-miles—so the amount of cargo and how far it’s moving. If you take 30% containerized trade, and you add 50% to that, that’s a 15% boost almost overnight to the demand measured in ton-miles. So if your market is fairly tight, you’re going to see rates go ballistic. And that’s what we’ve seen. We’ve seen containerized trade rates go up between 2x and 3x just over the last month. And we’ve also seen tanker rates tightening a little bit more as well.
Jake Davidson
I want to get into what that response has been and how those prices have moved. But before we move on, could you just provide some additional context on the specifics of these attacks, just to get a sense of the severity? You mentioned Somali piracy—maybe that’s a good comparison to start with.
J Mintzmyer
Yes. It’s a great question. Somali piracy—that peaked, I would say, five or six years ago. Those were mostly little speedboats: you’d have an armed crew of three to five people on a speedboat, and they’d approach the ships and try to board them, try to hijack them. Once the shipowners started to hire armed guards and there was a little bit more of a heightened naval presence there—once those reactionary measures were imposed, the piracy threat kind of fell off the radar.
But the Houthis are doing their attacks in three prongs. They’re using these unarmed suicide drones; they’re using surface-to-sea ballistic missiles; and they’re also doing the speedboat-hijacking-type tactics. So they’re coming at this in three different waves. So far, thankfully, no crew members have died. No ships have been sunk. So it’s mostly just an emerging threat.
Chapter 2: Response of Shipping Companies
Jake Davidson
Given the severity of these attacks and the increased risk, how have shipping companies responded?
J Mintzmyer
If you think about the risk adversity of a lot of these shipowners, an average container ship now—they’ve gotten much larger over time. So a lot of these ships have 10,000, 12,000, 15,000 units of cargo on these vessels. We’re talking total cargo volumes and value of maybe $2, $3, $4 billion per ship. So the amount of potential damages—even if it’s just a partial loss of the ship, let alone a total loss—you’re thinking about the lives of 15 or 20 crew members; you’re thinking about $2 or $3 billion of cargo. And so the risk calculus, even if it’s just a fraction of a percent, really, really pushes these shipowners to decide to reroute their vessels. And that’s why we’ve seen container ships do that.
We haven’t seen the same coordination on the tanker side because the tanker cargoes are closer to $50, $60, $80 million, which is still a big amount, but it’s an order of magnitude lower than it is for container ships. And the other factor there is, the container-shipping fleet is very consolidated—it’s an oligopoly. The top three or four owners control like half the market. So it’s a lot easier for those shipowners to come together and—in the interest of safety, they can come together and decide we’re not going to go through this, we’re not going to take this risk. And in a normal market, that might be considered collusion—anticompetitive practices. But when it’s a matter of safety, loss of life, loss of massive cargo values, it’s a little bit different.
The tanker markets are far more fragmented. You have hundreds of different owners and traders moving through that region. So we haven’t seen the same risk adversity in the tanker owners yet. I think that’s why you’ve seen the tanker rates—they’re strong. The market’s already tight. You’ve seen the tanker rates inch up, I’d say, 20%, 30%, 40% on average. But you haven’t seen that same 2x or 3x impact. And that’s mostly because the tanker owners until very recently had not started diverting around.
Jake Davidson
You mentioned ships being diverted through these less-efficient routes. Can you just speak to how these alternative routes compare to the normal ones, in terms of the added time and distance?
J Mintzmyer
It depends of course. There are lots of different sources from Asia, and there are lots of different final destinations in Europe. But one of the most popular routes is China to Rotterdam, which is the Netherlands—that controls a lot of the volumes there. So the container ship would leave the Asian region, and it would go around India and the Middle East, and it would go through the Red Sea, through the Suez Canal, through the Mediterranean Sea, and the stuff that’s going to Southern Europe would then dock in the Southern European ports.
The stuff that’s going to Northern Europe, which is actually the majority of it, would then go through the Strait of Gibraltar, which is south of Spain. It would go around over there by the UK, and it would dock in Rotterdam. So that’s the normal route. Again, it depends on the exact destinations and the partial locations, but you’re talking about a voyage of 40 days, 45 days, somewhere in there—maybe 50, if they’re slow steaming or there are canal delays or things like that.
Now, if that same vessel that we just talked about, that same route, now they’re going south of Africa, and going all the way around, it adds anywhere from 15 to 20 days to that voyage. And so, roughly rounding, that’s where you get the 50% increase in voyage length.
Jake Davidson
So let’s connect this to the prices specifically. How does the significant increase in the voyage length impact shipping prices?
J Mintzmyer
So already, as of now—and this is not every single container ship diverting, this is more than half, about two-thirds of the volume is diverting—we’ve already seen shipping rates go up between 2x and 3x. So a 100% to 200% increase depending on the routes. But these ships are mostly interchangeable between different routes. So even though it only impacts one major route, which is Asia to Europe, it’s impacting the globalized market price of these rates. So they went up—they’ve doubled to tripled as of now.
Jake Davidson
Another part of that rise in shipping rates I want to ask you about is the rise in insurance costs. Can you just talk through a little bit how that cost increase is contributing to the shipping price pressures?
J Mintzmyer
That’s a good question as well. There are two reasons. One of them is just general risk adversity. You’re not wanting to put your crew members at risk. You’re not wanting to take that element. But the economic side of things is the changes in war risk premium for vessels that are transiting the Red Sea route. Normally the war risk premium is a fraction of a percent. It’s maybe a few thousand dollars per voyage. It’s not necessarily a huge deal. That war risk premium has moved up into the single percent digits—so maybe 1%, 2%. That’s a 100-fold increase in the cost of insurance. If you’re talking about a 1% or 2% war risk insurance cost on a cargo worth $1 billion, that’s a massive amount of money. And so I think that’s the economic impetus behind why a lot of these container vessels are diverting.
When you look at some of the other vessels like tankers and bulkers, a lot of the crew members of these vessels are either outright refusing to participate in voyages that go through that region or they’re demanding a double or triple hazard pay. So that’s another needle mover on the economic side.
Kate Dunbar
J, can I just jump in here for a second? Could you take a second to talk through who’s paying those spot prices? As for the flow-through to inflation, what’s going to matter is the combination of who’s actually facing those price increases—so the 100-200% that you mentioned in the spot—versus how many of the companies are paying on much longer-term contracts.
J Mintzmyer
Certainly, Kate. It’s a great question. The majority of large-scale traffic is done under these longer-term contracts. These are typically—they’re one-year contracts, and they’re normally negotiated between about February and April of each year, and they’re normally signed in April or May. And so this year, there have already been rumblings or rumors that those contracts are going to be signed closer to May or June. I think a lot of customers are taking a wait-and-see approach to see if the air strikes and the other actions are going to stabilize the region a little bit more. So that negotiating period has been moved back a little bit, extended a little bit.
But if we fast-forward to April and May, and we’re in the same position we are today—if everything’s just kind of status quo—then we’ll see those contract rates roll up significantly, and then you’ll probably see contract rates double or triple for the following year. You’re absolutely right, Kate. That’s the point in time—again, April, May, June of 2024—that’s the point in time when we can follow up and say, OK, this is really going to have a major impact for the holiday season. This is going to have a major impact on big companies like Amazon, Walmart, Costco—those major importers.
As of now, it’s mostly the spot buyers—the just-in-time people—who are paying most of these impacts. It hasn’t really broken too many markets. The only markets we’ve seen that have broken are the last-minute, very-high-value items. We’ve seen some automobile chips—automobile chips have been in shortage for the last several years, so this is just continuing that issue. But there were some news reports about Tesla wasn’t able to get enough of their chips through and things like that. Those very-high-value items can normally be diverted to air cargo. Now, air cargo costs about 10 times as much as maritime cargo, sometimes 20 times as much. But if you’re talking about things like iPhones, or chips, electronic chips for vehicles, those are very value-dense items. So you could probably pay 10x or 20x more, and it would only be a few hundred dollars more for the final vehicle, the final product. If you’re talking about a $70,000 vehicle, a couple of hundred dollars more is not going to make or break anything.
Jake Davidson
You’ve alluded to this throughout the conversation a little bit, but can you just walk through more specifically which goods have been most impacted by these disruptions?
J Mintzmyer
Yes. It’s primarily retail goods—so anything that would go into a containerized box, in these 20-foot to 40-foot boxes, the kind of stuff you see on a railroad car or on a truck. So anything you’d buy at Target, Walmart, Amazon—those sorts of goods are the most impacted by this. Again, keep in mind, it’s not just the Asia-to-Europe trades; it’s impacting even China to the US, going into LA and Long Beach, because any time the global price moves, the demand increases for this sort of traffic, this sort of vessel, it’s going to impact worldwide markets. So it’s basically going to hit all sorts of retail goods.
It’s similar to the impact—not as large but is similar in theory—to the impact that we had back in 2021 when we had the supply-chain crisis, and people were talking about Christmas being canceled. This one is not going to necessarily impact availability on store shelves because we do have decent capacity available. We’re not seeing port congestion, at least not yet. There are probably not going to be shortages on shelves, but the cost of goods—because shipping is an important cost whenever we have these global trades—that cost is certainly going to rise. And during the supply-chain crisis, we saw shipping rates go up by 10x, and so far we’re roughly 2-3x. So we’re not at the magnitude that we saw in 2021, but we’re certainly moving in that direction.
Chapter 3: Forward-Looking Picture
Jake Davidson
All right. So, J, you’ve described how things are up through now in terms of what’s going on, what the disruptions are. How are you seeing the impact of this issue and the trajectory of this issue going forward?
J Mintzmyer
Well, every time we look, every other day, there are different strains of news flow. And just to talk you quickly through what we’ve seen so far: the diversions started in the middle of December, and Maersk, in particular, but also CMA CGM—which is a French company, a very large liner company—MSC, which is based in the Mediterranean. Those three companies—Maersk, MSC, and CMA CGM—were lobbying heavily for protection, some sort of military convoy or military guarantees, and the US did respond. It’s called Operation Prosperity Guardian, and they launched that around Christmastime.
In response to that, around Christmas Eve, Maersk announced that they were going to continue—they were going to bring their vessels back and try to work them through the Red Sea and the Suez Canal. But even after the US assembled a small coalition to go protect that area, the attacks continued. In fact, the attacks actually increased during that period of time between Christmas and right after New Year’s.
So then the US very recently, as you’ve seen on the news, launched selective air strikes into Yemen. And that was a warning. They didn’t really target personnel. In fact, they choreographed the attacks very clearly. We saw the leak that came out of the UK. The prime minister was going to go talk to his cabinet, and it was leaked that the UK was going to participate in strikes immediately. That was probably deliberate because this was meant to be a choreographed warning strike.
But the Houthis responded right after that with more attacks on vessels. They said they weren’t going to stop. And so now we’ve seen this tit for tat, where every time the Houthis attack a couple of vessels, the US and the UK and that coalition strike a few more targets in Yemen. And it’s been going back and forth now for a little bit more than two weeks. It doesn’t seem—I wouldn’t say it’s necessarily worsening. The volume of attacks is about the same, maybe slightly less. The impact of those attacks is about the same. There’s slight vessel damage; there are concerns, but there hasn’t been any loss of life, there hasn’t been any vessel sinking, thankfully.
But now it’s sort of a status quo of a tit-for-tat back and forth. The Houthis will attack vessels, the US will selectively strike a couple targets, and the shipping companies continue to mostly divert. The one thing that did change about a week ago, closer to 10 days as we’re recording—we’re talking on the 23rd of January 2024—about 10 days ago, several large tanker owners, most of the ones that were controlled from the EU—a Norwegian company, some Greek companies—they also publicly announced that they were going to avoid that region. So it’s escalated beyond just container traffic, and now it’s impacting tanker rates.
As I mentioned earlier, tanker rates are up 20-30%, so it’s not the 2-3x movement. But just those handful of companies that are now diverting has already moved rates up by 20-30%.
Chapter 4: Cross-Cutting Pressures
Jake Davidson
I want to ask two last questions to wrap up on shipping, and then let’s move to Kate.
The first is, you’ve described this particular pressure on shipping very clearly, but it’s just one pressure. When you zoom out and look at all of the cross-cutting dynamics affecting shipping—the Houthi strikes, but also supply/demand, some of the ESG considerations you mentioned in our previous podcast—how would you net all of these pressures in terms of their impact on shipping prices right now? And are some of these other dynamics lessening or worsening the impact of the strikes in the Red Sea?
J Mintzmyer
Well, it’s certainly worth seeing the problem in all markets, and especially in tankers. Because the interesting thing about the tanker market is the supply-and-demand balance is already extremely tight. There’s not any additional capacity available. And part of that is due to pressures we’ve talked about in previous discussions. The global tanker fleet is the oldest it’s ever been. The order book is one of the smallest it’s ever been, so there’s not a lot of new capacity coming online. There are a lot of new environmental regulations that started last year and will continue to escalate throughout the next five years, which will push older capacity offline. They also had the Russian invasion of Ukraine and the subsequent sanctions on Russian oil and product exports. So you already had this very tight market. So the tanker rates—they’ve only moved 20%, 30%, maybe 40% as of now. But if there’s a total shutdown or a total diversion of tanker rates, those could go ballistic really quickly.
The container market, as I mentioned, it’s moved to 2-3x. And the container market I would say is bordering on oversupplied at this point. So even with an oversupplied container market—and I say oversupplied assuming everything’s working, everything’s functioning normally. But even with that oversupplied market, we’ve seen rates go 2-3x because containers are almost 100% avoiding that region right now.
If tankers go from partially avoiding to fully avoiding, we could definitely see those rates move up, and that will impact consumers directly in terms of gasoline prices; will impact manufacturing industrial bases in terms of crude oil prices; and all those sorts of things. You might not see the global price of crude oil move because that’s just traded on international benchmarks. But the actual landed price, what the actual consumers and gas stations and refineries and such are paying, those prices will move up.
Chapter 5: Impact of Higher Geopolitical Risk on Global Trade
Jake Davidson
And then, last question, J, just to really step back. We’re in a world of what seems to be secularly higher geopolitical risks and a more multipolar world where the Pax Americana, underwritten by the US and its allies, is being increasingly challenged. Do you see this kind of disruption to global trade as becoming more common going forward as a result? Or does this look more like a blip than the start of a trend?
J Mintzmyer
I’m just going to speak academically at this point—not an official policy position or anything like that. But just looking big picture, any time we shift from a unipolar world, where the US—you called it Pax Americana—the US is controlling everything, into a multipolar world, where you have the major emergence of China, India is now a major player in that region—any time you have that sort of situation, and you have a threat from someone like the Houthis, or you have this crisis in Gaza, you have to have a coalition that assembles the actual key players, real players. Your coalition right now in Operation Prosperity Guardian is the United States and the UK. Then you have the French, who aren’t participating directly in the operation, but they have sent some naval assets. And that’s great. That’s the response they need to take.
But if they want to completely make the area safe, or solve the problem, they have to include the players that actually matter, including China, including India, including some of those more, I would say, more relevant maritime players in that region. Because if you look at China: China is the number one most dominant maritime exporter in terms of containerized finished goods. They’re also the number one importer in terms of commodities in dry bulks, in liquid cargoes. So they’re the most major player; they’re the ones with the most at stake here. So if you want to fix this situation, it has to be a joint effort with those partners that matter in terms of economic trade.
We haven’t seen that. Even with Operation Prosperity Guardian, there hasn’t been a lot of buy-in, even from the Western nations. In fact, the UK was the only country that joined with the air strikes in Yemen. I believe there’s a list of 9 or 10 countries that are supporting the operation, but they’re not supporting it directly with assets on the water. They’re just supporting it in principle.
Jake Davidson
Just a quick follow-up because that’s an interesting point. Given the significant impact that these attacks have had on China’s trade routes, could you say a little bit more on how China has responded?
J Mintzmyer
They’ve deployed a few assets over to that region, but they haven’t participated in any counterstrikes or defensive actions. The Chinese have a naval outpost—it’s not quite a full-up naval base—but they do have a naval presence in Djibouti, which is over there by Somalia on the western side of that choke point. So China certainly has the capacity to take action here. And I don’t know for sure, but I would imagine there are back-channel things going on.
But China’s particular interest is mostly on the other side of Yemen, which would be the Strait of Hormuz. That’s where most of the Middle Eastern oil exports flow out of. So that’s where if that strait became endangered—because Iran has threatened throughout the decades—I mean, this is nothing new. But every time tensions inflame, one of Iran’s threats is that they’re going to shut down the Strait of Hormuz. I think that would be the point at which China would become very involved and very interested.
At this point with the containerized trade, it’s certainly hurting China a little bit, but they’re able to have their goods be diverted around. Shipping costs in most goods maybe are 1% or 2% of the total cost of the good. So even when we say they’ve tripled, they’ve gone from 1% or 2% to 3-6%. So it’s not that magnitude of impact where China’s going to want to commit military resources. China’s always had this sort of policy, at least in the last 20 years, where they like to play or pretend like they’re a neutral participant or they’re a neutral observer. They don’t like to pick sides on these sorts of things. So far, China’s just continuing that status quo.
Chapter 6: How Supply Chain Disruptions Flow Through to Inflation
Jake Davidson
All right, Kate, I want to turn to you now. As macro investors, the major way this topic matters for us is how the supply chain disruptions flow through to inflation. You wrote a Daily Observations recently on our inflation outlook, which touched on this topic. How are you seeing the inflationary impact of the shipping disruptions so far?
Kate Dunbar
So as J mentioned, shipping is one of the pieces of the costs for a good. But you have a lot of other sources of the costs. And you have businesses making choices about just how much they want to handle those increases in costs themselves or push them onto consumers. And so, in total, transportation accounts for between 1% and 2% of the final cost for a good. Most of the shipping costs that we’re talking about are negotiated over longer-term contracts.
So where we are now is, even though you’ve had these disruptions going on for approaching a month now, you’re not seeing that yet start to pass through to the prices facing consumers. And we wouldn’t expect to see that pass through to consumers for a while, unless this thing is sustained for some time, as it doesn’t change the end price for most of the goods that you would be receiving from big-box stores. So that’s one piece.
Then I would say, I think it is easy to hear about shipping disruptions and draw the parallels to COVID. And it’s important to draw a little bit of a distinction between what was happening in the COVID period and what’s happening now. The first thing is, as J already mentioned, there’s a difference in the order of magnitude to date of the moves in the prices—something like 10x increases in the worst of the COVID period and more like 2-3x today.
But you also had things like a huge surge in the demand for goods happening at the same time. And so people really wanted to get their hands on goods as much as they could. And businesses were able to pass those costs on because they were facing that wall of demand and consumers that were willing to pay.
Then, finally, you had complicating the shipping disruptions a series of labor disruptions that meant that at every stage of the supply chain, it was hard to get people to move the goods. So even if the ships reached ports, you struggled to unload them, and that created increasing problems; and then struggled to get them over the ground to where they needed to go.
So all of those things happening at the same time were a key part of the huge surge and subsequent normalization in goods inflation. Right now, we’re really only experiencing a disruption to one piece of that. The demand for goods has slowed a lot, and even with growth moving along at a healthy pace today, a lot more of that growth is in services. You just have less of that kind of clogged-up picture of people needing to get goods.
You also have inventories in a much healthier place than where they were, as companies experienced the drawdown in those inventories and seek to build them back up. So you have a little bit of buffer in that way. The labor disruptions are much less of an issue today. So when you look at that, you have a much healthier supply chain than what we had during COVID. And so the impacts of this are likely to be, for now, much smaller and are happening in an environment that is a little bit less broadly inflationary.
With that said, this is a marginal upward pressure, and so it could quite easily flow through to seeing a little bit more goods inflation. It will likely flow through to places where the shortages still haven’t fully normalized in the post-pandemic period, autos being one of the real places that we’ll be watching to see just how big a deal this ends up being.
And there will be some regional differences. While the overall impact on shipping prices should be similar globally, the risk of shortages is most acute in Europe. Europe is an area that’ll be much more exposed to the particular routes where prices are rising. So we’d expect to see a little bit more of an impact on Europe than, say, the US; though shipping and global goods trade are very correlated, so there will be some impact.
So overall, it’s largely, for now, something we are tracking as likely to be a marginal upward pressure, but not something that is likely to be a repeat of the same kind of experience we had coming out of the pandemic.
Chapter 7: Fitting This Disruption into the Broader Inflation Picture
Jake Davidson
How does this disruption fit into the broader inflation picture, particularly given the complexion of the inflation pressures across goods and services, and how goods in particular has contributed to some of the disinflation we’ve been seeing recently?
Kate Dunbar
I think it’s helpful to go back a couple of months and tell the story a bit of how we got to where inflation is today. We talked a bit about goods coming out of the pandemic—huge surge in goods inflation and then as things normalized, you started to see goods inflation fall. It’s running flat in the US now. You even saw a little bit of deflation. At the same time, you had services inflation rise with a bit of a lag to goods, but rise pretty much everywhere. And then it has softened some, particularly as some of the most acute labor shortages have cleared. But it’s still running at levels that are well above central bank targets. Finally, you’ve had what’s been going on in housing inflation, which—pretty lagged but high and staying roughly where it is.
Over the last print or two in the data, you’ve seen the pace of declines in inflation slow some, mostly as the falling in goods prices has slowed, and some of that services data has still held up. When we look forward at the pressures on inflation over the next year, we expect to see a little bit more continued normalization—so inflation falling and getting close to 2%, but not quite there yet. That’s a reflection of a combination of housing continuing to normalize as a lot of the pressures that led to the disruptions there mostly normalize and that data reporting catches up to what’s actually going on in the rental market and to the softer demand there.
And then we’d expect to see services remain pretty hot absent something like declining wage growth. So you might get a little bit softer services prints as wages normalize a bit, but likely to stay roughly where they are. And then the broad-based pressures on goods are consistent with more continued weakness, with this pressure being the main thing that cuts in the other direction.
So against the shipping disruptions, you’ve had the things like the big declines in commodity prices that will flow through to lower costs for the materials that the goods are made of. At the same time, you still have the demand rotating, and so less demand for goods, many of the other sources of cost coming down, and so still mostly disinflationary. But that could change. And this disruption is one of the key ways that could change and could alter that forward-looking view.
Jake Davidson
J, Kate, thank you so much for joining me and sharing your thoughts. And J, thank you for coming back on the podcast. I look forward to talking with both of you again real soon.
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