By Michael Every of Rabobank
Same Ship, Different Day
Last year, we published a report called ‘In Deep Ship’, which argued: supply chains were breaking down for a number of reasons, not just excess demand; this process would continue until a downturn; but politics and geopolitics meant even that would just provide a pause, not a structural reversal. The deeper I dug, the more I was personally convinced inflation wasn’t transitory, and that rates would have to go up and stay up.
Today it’s a case of same ship, different day. Ocean freight rates on many, but not all, routes are tumbling due to a looming downturn. Yet politics and geopolitics are still showing inflation is not transitory, even if it may have peaked, and central bankers are saying rates will have to go up further and stay up.
The Fed’s Bullard could not have been more hawkish yesterday. Not only did he shrug off weak data and say rates should go to 5.00% - 5.25%, but he made clear this was the lowest level they should sit at. Indeed, he suggested they might need to go as high as 7% using the Taylor Rule. True, there are doves like Brainard lobbying for pivots too. However, the real world outside of short-term economic data backs the Bullard view more than Brainard:
Russia, Ukraine, Turkey and the UN have agreed an extension of the Black Sea Grain Deal - wheat prices are lower as a result. However, an Israeli tanker was just attacked by an Iranian drone. More such events will raise the cost of global ocean freight, or make it less viable, as the Black Sea route was before the Grain Deal.
Turkey is demanding all oil shippers passing through the Bosporus show insurance from December 1, which could restrict flows of Russian oil ahead of new EU sanctions.
Prices for LNG ships have soared, with only the recent warm autumn weather, now being reversed in the US, providing any temporary respite.
As re-/friend-shoring from China, despite kumbayanik dreams, will see a surge in demand on second-tier carrier routes that can only use smaller vessels, and declining demand on existing routes between mega-ports using the largest ships (which we dubbed ‘too big to sail’ last year). That will mean inflation and deflation in carrier rates simultaneously.
Ocean carriers are responding to a collapse in freight demand with blank sailings and scrapping older vessels – supply destruction to match demand destruction; which is why the White House has the industry in its crosshairs as a cartel.
Plans for national ocean carriers as fall-backs are still proceeding in several economies, arguably the only viable solution given breaking carrier alliances up would not make things cheaper in isolation. There are urgent calls for the US to ‘go back to the sea’ too to ensure its military sealift capacity, without which it can no longer be considered a Superpower.
In Australia, regulators ruled tugboat workers could not be locked out by their employer from today as it would cause too much damage to the economy: the ripple effect of how close we came to such a development is seeing their supply chains disrupted today anyway.
In the US, a rail strike is still possible: the American Chemistry Council warns a one-month strike could result in 700,000 lost jobs, a 4ppt spike in US PPI, and a 1ppt drag on GDP, while a two-month strike would mean PPI up 12ppts and GDP down 2ppts. And how does one resolve strike action from key workers on tugboats or railways? Large pay rises ahoy!
The low Mississippi and Rhine underline key rivers can no longer be relied on.
It may not float your boat, but the supply side is still inflationary medium to longer term, not just short term as yield curves suggest. That is before Europe is deindustrialised by higher energy prices. Moreover, the Pentagon says it now understands the real lesson from Ukraine is the need for “production”, as legislation calling for massive increases in US weapon stocks sits before Congress. Once the real power-players wake up to the fact that supply/production is all that matters, then we end up with really inflationary shifts in supply/production. That’s true even if an infinite supply of economists and Wall Street analysts say this can’t happen “because markets”.
Higher rates are hence needed for several reasons.
First, to clamp down on excess demand and asset bubbles – job underway.
Second, to anchor the US dollar during this transition. Recall oil maven Anas Alhajji stresses the oft-overlooked fact that a key part of the post-1973 ‘petrodollar’ deal with Arab oil producers was the US promise to provide them with a decent, safe return for their oil revenues – which is part of the reason why US rates went up. This may no longer apply to OPEC+ today, but the same dynamic holds true vs. muttering of potential dollar rivals backed by commodities. Try pivoting and see what happens alongside structural supply-side inflation pressures! The inverse is to note the power the dollar wields as rates rise - Fed swap lines become geopolitical life-lines.
Indeed, what’s the alternative pivoters are actually offering now from a bigger picture perspective? Bankman-Fried polyamorous Harry Potter Bahamian frauds exceeding that of Enron? More bubble gibberish for the likes of Masayoshi Son to waste billions on investing in?
Most foreign investors want a decent, safe return from Fed Funds; and the Pentagon wants a decent, safe return from US industry that keeps the US decent and safe.
On the surface things may look the same, but actually it’s a case of same ship, different day; or very different ship from what Wall Street has been sailing us for years.
But there are always slow learners - the UK, for example. Fresh after trying Thatcherite tax cuts on steroids, Blighty is about to try austerity on steroids. Chancellor Hunt’s budget will slash spending for years, take taxes to the highest level in decades, and allow energy bills to soar, smashing consumers. Hunt promises “Scandinavian quality with Singaporean efficiency” as taxes hit Scandinavian levels without any sign of Singaporean outcomes, let alone support for public housing, transport, and cheap, delicious hawker centres. So, “British delusion” or “British irony”? Apparently, this is ‘what the market wants’ – just not voters: I struggle to think of a UK constituency, and I mean that figuratively and literally, who will back this budget.
The greatest irony is that if the Fed does go to 7% because ‘same ship, different day’, then the Bank of England and Britannia will almost certainly be forced to keep pace with it anyway – so what’s the point?
But I find myself asking that question with depressing frequency given so many in markets ignore all the above and busily rearrange deckchairs on the Titanic every day.