Escalating tensions in the Middle East increased prospects of renewed supply chain disruptions following Hamas’ surprise attack on Israel and Israel’s subsequent invasion of Gaza. A new phase of the ongoing conflict saw Yemeni-based Houthi militants attacking cargo ships using the Red Sea and Suez Canal to move goods, particularly oil. This is a major trading route, but several cargo ship operators suspended Red Sea operations over concerns about possible attacks.

Read also: Global Commodity Prices Plateau, Threatening Inflation Targets Amid Geopolitical Tensions

The Red Sea’s role in global trade is significant. It allows cargo traffic to move between the Indian Ocean and the Mediterranean Sea, a much more efficient route compared to others. With some shippers choosing to use longer routes, it can delay the delivery of goods, with oil being one of the major commodities shipped through the Red Sea route to reach Europe and the United States. Choosing a longer delivery route could cause potential delays and near-term supply shortages. Markets will be watching closely to see if supply chain disruptions resulting from impediments to shipping on the Red Sea will have inflationary effects.

By early January of this year, oil prices remained steady and overall inflation moderated significantly, indicating that to this point, shipping challenges on the Red Sea had not yet translated to discernible changes to inflation’s 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 3.4% for all of 2023. 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

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.

The Red Sea’s role in global trade is significant. It allows cargo traffic to move between the Indian Ocean and the Mediterranean Sea, a much more efficient route compared to others.

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.

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. Since that time, supply levels improved, and lumber and other materials costs declined. 

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, helping bring prices down. As of mid-January 2024, oil stood slightly above $70/barrel a drop of more than 40% from its peak. 

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 Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. 

Based on recent jobs data, 1.5 positions are open for every available worker, demonstrating a need for more workers to fill available jobs. 

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 this year, 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% in the first half of the year. Growth jumped to an annualized rate of 4.9% in the third quarter. 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.

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