Red Sea shipping crisis stokes further inflation fears after Houthi attack

A missile attack by Houthi rebels on a Belize-flagged ship has dashed hopes for an end to the shipping logjam between Asia and Europe just as freight rates were stabilising, with retail consumers expected to bear higher costs.

The disruption to global trade is starting to percolate to retailers as spare part inventories sourced by Western manufacturers from Asia have started thinning. This has led to inflation worries resurfacing and clouded hopes that central banks would cut interest rates soon.

Ninety per cent of ships are avoiding the Red Sea due to the Houthis' sustained campaign of attacks from Yemen on vessels in the waters. This is causing ships to take two weeks longer than usual to reach their destinations, which in turn is causing a shortage of critical parts for manufacturers, said Blair Robbins, partner at Eisner Advisory Group LLC, a New York-based consultancy and accounting firm.

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Those disruptions have caused carmakers Tesla and Volvo to suspend some production in Europe due to a shortage of components. Without a resolution to the crisis in sight, it is now likely to affect manufacturers in other sectors as well, executives say.

If manufacturers are unable to get the key components they need, then "they are going to cancel orders for all the other components that they don't need because they're not making the product," he said.

Manufacturers are facing a double whammy as it is becoming too expensive to depend on inventories to tide over the supply crisis due to high interest rates, Robbins said. Since March 2022, the US interest rate has risen by one of its steepest levels in years.

"One way or another, the cost of your goods are being affected .... The longer [the shipping disruption] goes on, the more you'll start to see companies pass on the price to consumers," Robbins said.

The impact is likely to be more acutely felt when retailers start restocking shop shelves for spring in about a month, he added.

The attack on Sunday by Houthi militants came just as shipping schedules were starting to stabilise and freight rates eased marginally - after doubling in the wake of the attacks - as carriers added more vessel capacity and the pre-Lunar New Year demand rush ended.

The incident occurred just as the US military acknowledged conducting new air strikes targeting the rebels, indicating that the unrest is unlikely to subside.

"Concerns over a potential widening conflict in the Middle East will push up energy [and food prices], which will disrupt the global disinflation momentum. That will push back expectations of Fed rate cuts this year especially if the US job market remains resilient and the US economy is durable," said Bernard Aw, Chief Economist APAC at Coface, a global credit insurer.

Commodity prices, in particular energy, will shape the global inflation outlook this year, he added. Crude oil prices have risen by about 6 per cent so far this year amid the attacks on shipping, although that has been tempered with expectations that demand growth is slowing.

On Tuesday, benchmark oil futures were hovering near three-week highs with Brent Futures trading at US$83.48 a barrel and US West Texas Intermediate crude for April delivery quoting around US$78.36 a barrel.

"After easing substantially throughout most of 2023 - falling to levels significantly below the historical average - supply chain pressures began to pick up in the second half of last year and are currently back at pre-Covid-19 average," said Jamus Lim, associate professor of economics at ESSEC Business School, Asia-Pacific.

Global shipping costs have been rising steadily since touching lows early last year, spiking briefly in November following the Houthis' first Red Sea attacks, he noted.

"In my view, a re-emergence of supply chain disruptions represents the biggest upside risk to inflation in the year ahead," Lim said.

Investors have been pinning their hopes that the US Federal Reserve would start cutting interest rates to boost consumer spending and economic growth after its cycle of rate hikes. Asian and other central banks typically take their cues from the Fed.

"The emerging data are currently concerning but not yet worrying, but if inflation rates are to remain above the Fed's two per cent target through the middle of this year, I do not see how the Fed can embark on a rate cut cycle, whatever markets may be wishing for," Lim said.

Analysts said that the current global supply chain pangs are only the tip of the iceberg.

"Overall, it is likely that we are only just starting to see the impact of the Red Sea crisis filter through into production - with supplier delivery times globally [and in the UK and EU] having lengthened for the first time in a year in January," said Shanella Rajanayagam, a trade economist at HSBC.

"The longer shipping disruption persists, the more delays and disruption to production that can be expected," she added.

Businesses have been drawing upon inventories that they built up during the pandemic years. However, the stocks of manufacturing inputs have been contracting, [for instance] for the past 16 months for UK manufacturers, and for 17 months for US firms, Rajanayagam said.

"There is a risk that shortages could eventuate especially if it looks like the crisis might persist and businesses then look to rebuild their buffer stocks to help mitigate further trade disruption, triggering a rise in demand that could compound the existing disruption," she said.

Still, the impact of logistics on overall inflation has been muted though it remains an upside risk, she added.

Naik Londono, co-CEO & co-founder of smart container tech company AELER, said cargo owners are increasingly considering airfreight as an alternative to avoid shipping delays. Typically airfreight is used for expensive items like semiconductor chips or precious metals.

Some analysts say their expectations about lower interest rates are unchanged.

"It is possible that the current level of disruption is affecting shipping costs and therefore putting some pressure on inflation. But the magnitude at this point seems quite small and not significant enough to change interest rate policies," said Antonio Fatas, a professor of economics at INSEAD business school.

This article originally appeared on the South China Morning Post (SCMP).

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