#Breaking News...! is the norm in these fast-changing times. Every day, a fresh development will paint various eye-catching economic scenarios that will supposedly change our world. Without a doubt, the list is long for events that could (permanently) alter the established protocols and tacit agreements of conducting international trade.
Ambiguities such as the pandemic induced / politically motivated lockdowns, skyrocketing inflation (diminishing discretionary spending power) and interest rates hikes (bitter pill to swallow), temperamental weather and climate occurrences, war & geopolitical tensions etc. have challenged economists and analysts to revisit prior assumptions and forecasts more frequently than before. With that in mind, let us examine a few intriguing indicators that could trace to factors responsible for flipping the global economic script.
World Uncertainty Index (WUI):
WUI is a broad concept relating to macro phenomena like GDP growth intertwined with events like elections, wars, and climate change across 143 countries in the world. As depicted in the graph above, taking into consideration of all the “Breaking News” events over the past decade, global uncertainty reached unprecedented magnitude with the initial coronavirus outbreak in 2019. While it later plunged drastically, the index rose again with the outbreak of war in Ukraine whereby the world simply could not catch a breath to recuperate fully.
Now let’s focus on the World Pandemic Uncertainty Index which is computed by the number of times “uncertainty” is mentioned near a word related to pandemics or epidemics as per the Economist Intelligence Unit (EIU) country reports
Undoubtedly, the world has by far witnessed the highest uncertainty related to the coronavirus. Covid19 has impacted the world in far more ways than impacting the health of the affected. This had brought the global economy to a standstill with a slowdown of production, increased inefficiencies, impeded revenue, and inverted GDP for a prolonged period until a credible vaccine was produced which provided the lift needed for a robust demand rebound in 2021. As of writing, while the rest of the world had learned to live along with the pandemic (with inflation to worry on their plate), draconian response to renewed outbreaks in China under the “Zero-COVID” policy, coupled with its faltering property sector have seriously sapped economic vitality and consequently crippled Chinese demand for raw materials.
While there’s optimism that the “Zero-COVID” policy might be retracted following President Xi’s successful election at end 2022, the fact remain that the Chinese society had yet to achieve herd immunity due to its ineffective domestically-produced vaccines and reluctance to procure foreign vaccines. With infection rates already rising in the hot summer, one had to ponder the level of outbreak in the coming winter.
On a more optimistic note, we see some flickering light at the end of the tunnel with a fresh report of the resumption of construction projects by the Evergrande group in China this month.
To add further spin to the “uncertainty” narrative, Typhoon ‘Hinnamnor’ and ‘Muifa’ had led to several Chinese ports shut, giving a much-needed short-term boost in a current ailing dry freight market.
Economic Uncertainty:
The US Dollar and the Euro have long played a ‘duopoly’ as invoicing currencies in international trade, but an unexpected breakthrough in the Russia-Ukraine war has shifted the gears amid geopolitical tensions. As a result, the dollar’s share as foreign-exchange reserves have declined as countries opted for a non-dollar payment system.
For instance, Russia is urging its trade partners to pay in Rubles, China is promoting payments in RMB, and India is encouraging exporters to negotiate trade in Rupees among others. However, the International Monetary Fund (IMF) emphasizes that the reduced role of the US dollar is unlikely to match by increased share of the other currencies. Meantime, these currencies fluctuate widely against the US dollar, exacerbating forex risks.
Despite some pockets of optimism, one of the major concerns has been the rise in inflation as a repercussion of Russia’s invasion.
Evidently, global inflation has risen sharply this year from its lows (3.8% on average) in 2020 on account of rising property rates, soaring fuel costs, elevated freight rates, and the high cost of food grain.
In response to tame rising inflation, central banks worldwide (except China) are raising their core bank lending rates which in turn would weigh on consumer spending, concerning the demand for both – raw materials and finished products. The think tanks, however, expect inflation to stay moderately elevated at 7.9% in 2022 and gradually decline towards 5% from mid-2023 onwards. Whether this moderation in inflation down the road is a pipe dream or attainable goal hinged on the reality of the battlefield which is subjected to multiple variables.
In essence, countries with greater energy and food dependency will feel higher inflationary effects due to soaring prices amid supply-demand imbalances. The political narrative had officially pivoted from a ‘pandemic panic’ to that of ‘food and energy crises”. Europe’s latest “U-turn” on coal has increased demand for the dirty fuel from other long-haul exporters (at the expense of other coal buyers).
Coal, whereby prices recently hover around $450 (from about $200 in Jan-22), have been adding ton-mile demand (on selective routes) and cushioning freight as much it could against unwinding congestion. Similarly, limited grain exports out of the Black Sea have increased demand for grain supplies elsewhere. The grain supply gap is expected to fill in by South America, Argentina, Brazil, and the US. As far as shipments of wheat are concerned, Australia and India have been looked up as a respite to a certain extent.
Beside food and fuel, shipping is an important driver of inflation. According to IMF, when freight rates double, inflation picks up by about 0.7% points. The effects are quite persistent, peaking after a year. This implies that the increased shipping costs in 2021 have resulted in higher inflation in 2022
The monthly averaged graphs of Alphaliner Container Index (on the left) and Baltic Dry Index (on the right) have marched upwards indicating the higher freight for both segments from 2021 onwards had contributed their fair share for inflation in 2022. The recent correction in shipping rates might provide some respite in 2023. But most likely, it will be a scratch to the itch. Unless US and Europe can sort out their energy policy (investing in fossil fuel production and transportation capacity among allies), it will likely take more than a series of interest rates hikes by central banks worldwide to tame the inflation back to the official 2% target.
Exceptionally high crude oil prices coupled with historical natural gas prices is changing the industrial playbook. The Brent crude remained well above $100 for quite some time but fell below USD 95/bbl in August. The lower oil prices are being fostered by concerns that tighter monetary policy of central banks will limit the demand for oil and economic outlook over China. Lower oil prices are also being influenced by (recently) stronger US dollar, the release of oil from strategic reserves in the USA and the fact that Russia has so far managed to export larger amounts of oil to Asia. The EIA expects a stronger decline in the Brent price to $90.5/bbl in December and further around $86-88 88/bbl at the end of 2023. On the other hand, the gas price has been following only an upward trend after the war. The ICE Dutch TTF Gas Futures rose 600% from $33 last September to $206 this week. The gas price in Europe is not expected to come down due to a drop in LNG exports from the USA and a further fall in Nord Stream capacity. Moreover, a reduced flow of gas from Russia is jeopardizing the EU’s goal to fill their storage up to 80% in November.
To summarize, higher prices will hurt real disposable incomes, raised production costs & reduced volumes for importers. Yet, political inertia to effect change to combat economic problems seem to remain as stubborn as ever. Shipping, as a facilitator and beneficiary of this global trade order will have to cautiously navigate and tread on “thinner ice” in order to prosper or avoid calamity in a world of uncertainty (be it size or scope), surrounded by ad-hoc enforcement of sanctions. Clearly, the tides of fortunes could quickly swing from one party to another, while dry freight had been in the doldrums following an encouraging 1H22, tankers rates (including LNG) had spring into higher altitudes over the past month. To expect the unexpected, that’s what made shipping so captivating for us here.