US ecomony: Big risks and fragile supply chains ahead?

With inflation, wars and supply chain worries to contend with, is it too soon to predict a clear outcome for the US economy?

| 6 min read

The most recent set of US inflation data has jangled the nerves of financial markets. It showed price rises running ahead of expectations, up 3.2% for the year. Core inflation was even higher. However, the central assumption from financial markets is still that inflationary pressures will continue to abate. However, we would be more cautious - there are a number of factors that could disrupt a gentle path to the magic 2% inflation level.

Freight rates, for example, have been a key area of risk. They have spiked higher since mid- December in response to shipping disruption. There have been two main sources of problems for shipping lanes across the world. The first is the attacks on ships in the key Red Sea route from Asia to Europe, as Houthi rebels protest Israel’s actions in Gaza.

While the Houthis claim to be targeting ships that are either Israeli-owned or operated, or that may be heading to Israeli ports, many of the vessels they have attacked have no connection with Israel. It has created difficulties for international shipping, with major companies rerouting around the Cape of Good Hope in South Africa, adding up to 30 days to a typical round trip, and considerable cost.

A second problem has been severe drought in the Panama Canal. This is normally the wet season, and the time when shipping through the Canal is at its most fluid. However, a lack of rain has reduced transit slots from 36 to 24. The danger is that if rain does not appear soon, the problem will get even worse in the dry season.

These impact on freight costs, which impacts on the price of goods, which impacts on inflation. High costs threaten to disrupt fragile supply chains, that have only just recovered from the pandemic. Shipping costs are around 2x their level in October last year.

The Containerised Freight Index rose 105% from 21 December 2023 to 21 January 2024.

For the time being, there is no reason to panic. Demand is relatively low, and supply chains can adjust. Since mid-February, freight rates have started to drop again. However, it is an area that we are watching and would be a source of concern if demand were to pick up meaningfully.

Gasoline prices

It is not the only potential inflationary threat. Having dropped significantly between September and December 2023, gasoline prices have started to rise again in the US in response to some refinery problems and a running down of inventories.

This is a concern as the US heads into its ‘driving season’ – the period from April through to September when Americans typically go on holiday. If demand rises and there is no supply response, this could drive prices higher still and create inflationary pressures.

Shelter costs, which include rents, hotel and motel stays as well as school housing and conventional rents, have also been a source of sticky inflation. They are persistently above 5%, even though the rate of increase has come down. The problem is a lack of supply, particularly in certain under-pressure cities and regions. Between them shelter costs and higher gasoline prices contributed 60% to the monthly increase in the CPI for February.

Homeowners have a powerful disincentive not to move. Many have 30-year mortgages agreed at low rates, and moving would force them to remortgage at a much higher rate. High mortgages also mean fewer rental properties being bought, which is creating a supply crunch. This is helping keep prices high across the property market.

Insurance costs are also rising. Motor vehicle insurance, for example, is running at over 20%. It has been at that level for some time, and while it only represents around 3% of the inflation basket, the high percentage rise is adding around significantly to overall inflation.

There are a number of factors at work in higher insurance costs. Electric vehicle insurance, for example, is more problematic. It only takes relatively small amounts of damage to an EV to make it uneconomic to repair. Higher write-offs are pushing up insurance costs. Weather patterns are also a factor. There may also be some opportunist rises among insurers.

None of these factors mean that inflation won’t eventually find its way back down to 2%. However, it may take longer to get there. Certain parts of the inflation basket are proving particularly sticky, and the trend has been for inflation to surprise on the upside rather than the downside. This defers rate cuts still further.

Persistently high rates could deepen the US’s fiscal problem. Estimates vary, but the US is already spending between 15% and 20% of tax receipts on interest on its debt. That leaves little flexibility for the government to stimulate the economy if it starts to struggle. Ultimately, it may be too soon to predict a clear outcome for the US economy, or confirm that inflation is finally slayed.

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