Key takeaways
Shipping disruptions on the Red Sea have become the focal point of supply chain concerns in early 2024.
To this point, the impact on U.S. companies and consumers has been minimal, but it points to the potential risks of rising global tensions.
Moderating consumer demand for goods in recent months has helped alleviate broader supply chain bottlenecks, contributing to slowing inflation.
While there are no significant signs yet of major supply chain slowdowns owed to conflicts in the Middle East, it is an issue that is on the market’s radar. Of particular concern are disruptions to shipping in the Red Sea, a key link between the nations bordering the Indian Ocean and much of Europe via the Suez Canal.
Fallout from the Israeli-Hamas conflict include attacks by Yemeni-based Houthi militants on several cargo ships using the Red Sea to move goods, particularly oil. These actions forced several cargo ship operators to suspend Red Sea operations over fears of possible attacks. Instead, operators are diverting to longer routes, which could delay the delivery of goods. In the meantime, the U.S., Britain and other nations are using military resources to try to protect shipping in Red Sea lanes, so far with mixed results.
“The Red Sea is important in moving oil, particularly to Europe,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “There aren’t many goods headed to the U.S. that cross through that route, but if problems persist, it could have a temporary impact on oil supplies, possibly driving oil prices higher as a result.” Haworth notes that in terms of global imports, China is one of America’s most prominent trade partners, outside of border neighbors Canada and Mexico, and most China shipping occurs via the Pacific Ocean.
In the first two months of 2024, oil prices rose but only modestly, and changes in overall living costs remained at moderate levels, indicating shipping challenges on the Red Sea have not yet had a discernible inflationary impact. After peaking at a 9.1% rate for the previous 12-month period as of June 2022, inflation as measured by the Consumer Price Index (CPI) was down to 3.1% for the 12-month period ending in January 2024. Supply chain bottlenecks were a major concern during inflation’s surge in early 2021. The gradual resolution of many of those issues contributed to the improved inflation environment.
Will supply chain issues again become a flashpoint for the markets given the ongoing conflict in the Middle East?
Evolving supply chain concerns
Potential supply chain issues in 2024 differ from what initially sparked inflationary concerns in 2021. At that time, pent-up consumer demand spiked following the economy’s “shutdown” phase, due to the COVID-19 pandemic. As consumers ramped up spending, supported by emergency government support programs to households and businesses, the global economy faced a shortage of commodities, parts or products that resulted in a supply-demand imbalance, forcing prices higher.
“Higher inflation reflected a restricted supply of goods at the same time that there was strong demand for many of those same goods,” says Tom Hainlin, national investment strategist at U.S. Bank. Energy and food products were leading drivers as inflation soared. The war between Russia and Ukraine, for a time, interrupted some shipments of energy and agricultural commodities from both countries. China's COVID-19 lockdown policies, which were in place until late 2022, hampered manufacturing and shipment of goods from Chinese firms.
Yet supply chain issues affecting a wider range of products also contributed to the problem. Some companies had difficulty keeping up with demand, sourcing components needed to manufacture products or finding enough workers to fill production needs. In addition, transportation challenges arose, including a backup of shipping traffic in some ports and a shortage of truckers to haul freight over long distances.
For the most part, the worst of these challenges have subsided. Manufacturer supplies improved and consumers are finding most goods readily accessible. The economy also transitioned from one driven by demand for goods to increased spending on services, including travel and entertainment.
“After a sharp jump during the initial COVID-19 period in 2020, goods demand flattened out beginning in 2022,” says Haworth. “Inflation today is much more visible for services than for goods, based on recent Consumer Price Index data.” The slowdown in the growth of goods demand has put less stress on supply chains. “This situation is likely to change, and we’d expect growth in goods demand to follow a more normal pattern in the coming years,” says Haworth.
Most notable is the disruption of shipping in the Red Sea, a key link between the nations bordering the Indian Ocean and much of Europe via the Suez Canal.
Personal Consumption Expenditures: Goods. Source: U.S. Bureau of Economic Analysis, February 22, 2024.
Commodities markets adjust
Significant improvement occurred in the broader commodity markets by the end of 2022. For example, in the spring of 2021, shortages of building materials hindered construction of new homes and remodeling projects for existing homeowners. That drove prices of lumber and other materials dramatically higher.
Similar trends occurred in the energy sector. The price of a barrel of crude oil topped out at $123.70 in March 2022. For a period of several months, Americans paid much higher gasoline prices than they had over the prior two years. However, supplies were bolstered, and demand eased, leading to a price reduction. As of late February 2024, the price of oil was under $80/barrel, a drop of nearly 37% from its peak.1
Chip shortage
Another prominent story related to supply chain issues was the so-called “chip shortage” referring to a lack of semiconductor components. Chips are used in virtually every digital electronic device today. Dating back to late 2020, a backlog of chip orders led to a shortage of many products including automobiles. Higher costs for new and used cars were another major contributor to the rapid increase in the overall inflation rate. Supplies of chips began to improve in 2022, due to a combination of increased production and a slowdown in sales of personal computers, smartphones and consumer electronics.2 That helped ease price pressures.
The new CHIPS and Science Act incentivizes construction of domestic semiconductor manufacturing plants. It includes a commitment of $52 billion to support the development of the domestic semiconductor industry. “New factories are under construction in the U.S.,” says Haworth, “but it will likely be 3-4 years before they are up and running.” While not a quick fix to chip supply concerns, it may provide more long-term supply-chain security in the semiconductor market.
Labor shortages and other challenges
Some issues may persist because there are not enough workers to fill available American jobs. “While supplies and transportation hubs seem to be keeping pace these days, labor shortages may be the biggest issue affecting the supply chain,” says Haworth. Based on recent jobs data, approximately 1.5 positions are open for every available worker, demonstrating a need for more workers to fill available jobs.3
In today’s environment, unemployment lingers near historic lows and job openings remain high. “The major challenge for many employers is whether they can attract and retain sufficient quality labor to meet their production demands,” says Hainlin.
Where we go from here
The Red Sea shipping issue is one of the latest challenges facing supply chains. It’s not clear at this point whether it will create a significant economic impact that could fuel an inflation uptick. The Federal Reserve remains focused on bringing inflation down to its target range of 2%. The Fed raised the short-term target federal funds rate by 5.25% over a 16-month period. Because inflation dropped significantly from its peak, the Fed has indicated it may be prepared to start cutting the fed funds rate in 2024, but the timing of such a move is difficult to predict. Interest rates remain higher across the broader market, resulting in more expensive borrowing costs. This was one of the Fed’s objectives, designed to help lower demand, which could also help ease supply pressures and slow inflation.
Through all of this, the U.S. economy demonstrated resilience in 2023, avoiding a recession. The economy grew by about an annualized rate of 2.5% in 2023, an unexpected improvement on 2022’s growth rate of 1.9%.4 Persistent consumer demand and a strong jobs market greatly influenced economic growth. Investors will continue to monitor these data points in the months ahead to determine the impact on corporate profits and stock prices.
Talk with your wealth planning professional to determine how economic developments such as inflation trends may impact your own investment strategy and your long-term financial goals.
Frequently asked questions
If disruptions in the supply chain result in a situation where demand for products or services outstrips available supplies, it can result in significant price increases for affected items. For example, consumer demand for goods soared in 2020 and 2021, during the early months of the COVID-19 pandemic when activities (such as entertainment events) were limited. Manufacturers were not able to meet demand for a variety of reasons, including increased consumer demand and shortages of available materials. As a result, costs for some items jumped, and the broader inflation rate surged. This affected monetary policy (higher interest rates) that may have had a dampening effect on the economy.
Specific sectors of the market can be subject to supply chain issues. If supplies for certain items are restricted for a period of time, it can impact the ability of companies within related sectors to meet customer demand. That could result in lower revenues and earnings, a development that could potentially be reflected in lower stock prices.
If specific types of products become scarce due to supply chain disruptions, consumers may not be able to readily obtain them or will have to pay an inflated price for them. This is similar to the issue that occurred with building supply prices in the early days of the COVID-19 pandemic. Demand for housing and home renovations surged, straining available supply, resulting in major price increases for lumber and related materials.
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