What conflict means for supply chains

22 January 2024

Recent missile attacks on ships travelling through the Red Sea have put supply chains back in the headlines. It is the latest in a line of recent trade disruptions that started with the dislocation of supply chains during the COVID-19 pandemic. These problems were exacerbated in 2021 when the Suez Canal was blocked for six days by a container ship, the Ever Given, which ran aground. In February 2022 Russia’s invasion of Ukraine caused severe disruption to shipping in the Black Sea, and Ukrainian grain exports, causing grain prices to soar.

Now Houthi rebels in Yemen are attacking ships in the Red Sea as part of an escalation in regional tensions over the conflict in Gaza. The Red Sea route via the Suez Canal is an artery of global trade, accounting for about 15% of seaborne freight. The attacks have halved container traffic through the Red Sea forcing some freight to re-route via the Cape of Good Hope, adding 20 days to journey time, and some high-value goods to be shipped by air. Container freight rates have more than doubled since 1 January prompting fears that the disruption will give a fresh impetus to inflation.

For now the risks to the global economy seem contained. The disruption to trade comes at a time of weakening growth in Europe that limits the ability of companies to pass on higher costs to consumers. Freight rates have risen but are at a fraction of the peak levels seen in 2021-22. Shipping costs are a relatively small proportion of overall consumer costs. The fact that the oil price has not reacted, and is lower than on the eve of the Israel-Gaza conflict, suggests that the effects of the attacks in the Red Sea have so far been relatively limited.

This would change if the conflict were to widen, or drag on. At a time of elevated economic uncertainty, the Red Sea attacks represent a new and unwelcome risk to growth.

The Red Sea attacks, like US-China tensions and Russia’s war in Ukraine, are straining the old economic order. Western policymakers have responded by seeking to build national resilience, for instance, by reducing trade dependence on potentially hostile states and diversifying supply chains.

In the golden era of globalisation of the early 2000s ‘offshoring’ production to take advantage of cheaper labour was all the rage. Now, with the global international order fraying, the talk is of reshoring, near-shoring or friend-shoring. Western governments want shorter, more diverse and more resilient supply chains.

Change is indeed happening. But a recent study by the Bank for International Settlements (BIS) suggests that the new supply chains that are emerging are just as vulnerable, and even longer, than the ones they replace.

Direct trade between the US and China has indeed weakened in recent years, pointing to a reorientation of American trade away from its principal rival. Yet, instead of sourcing products from other countries, the BIS finds that US companies are continuing to buy Chinese products through other Asian economies. There are simply more links, or countries, in the supply chain. The counterpart to the decline in the share of direct trade between the US and China has been an increase in trade between China and other Asian economies, notably India and Vietnam, and, in turn, a rise in trade between those countries and the US. Courtesy of lengthening supply chains, US-China trade links remain strong and, increasingly opaque.

The BIS study suggests that an age of geopolitical tension has given rise to greater complexity, not to an unwinding, of supply chains. Not only does the US remain dependent on China, longer supply chains spell greater cost and reduced transparency in product sourcing.

We seem to be a long way from diversified and resilient supply chains sought by Western governments. On the contrary, dependence persists, but with greater complexity and cost. Unwinding globalisation is proving difficult, and costly.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index closed the week down 2.1% at 7,462. UK equities were hit by unexpectedly high December inflation that knocked market expectations for early interest rate reductions. US equities reached new intraday highs on a strong performance from tech companies

Economics

US consumer sentiment registered the biggest jump in many years providing further evidence of the resilience of the US economy
US jobless claims hit a 16-month low signalling that the US labour market remains tight
US home sales fell to the lowest level in 28 years in 2023
Global oil demand growth is projected to halve in 2024 due to China's weak recovery, a slowdown in major economies and increased take -up of electric vehicles, according to the International Energy Agency
UK consumer inflation rose marginally to 4% in December – the increase was unexpected and caused markets to scale back expectations for interest rate cuts in the first half of 2024
UK wage growth slowed to 6.5% in the three months to November
Retail sales volumes in Britain sharply fell by 3.2% between November and December, significantly more than expected and adding to the risks of a UK recession
UK house prices fell by 2.1% in November, the sharpest decline in more than a decade
UK mortgage defaults grew in Q4 2023, and banks expect them to increase further in the next three months
European Central Bank president Christine Lagarde said it is likely that the central bank will cut interest rates in the summer
Germany’s economy contracted by 0.3% in 2023 as retail sales, exports and industrial production suffered as a result of high energy prices and elevated interest rates
The German finance minister Christian Lindner admitted that the country is the “tired man of Europe” after its latest GDP contraction and it would need reforms to recover
Economists warned that the German construction union IG BAU’s demand for a 21% pay rise for almost a million workers could fuel further inflation and postpone interest rate cuts
China’s economy grew by 5.2% in 2023, beating the official target, as industrial production rebounded in Q4 2023
China’s population declined for a second year in a row due to low birth rates. Economists warned that the population is likely to continue shrinking and this will dampen long-term economic growth

Business

UK retailer Poundland’s owner Pepco warned of the potential impact of disruptions in the Red Sea, which is increasing freight costs and disrupting supply
A UK judge ruled against an employee who wanted to work from home full time, finding that the office was a better environment for rapid discussion and non-verbal communication
Revenues and profits for the world’s largest chemical group BASF tumbled last year due to high energy prices and a slowdown in manufacturing demand
US retailer Walmart announced a 9% increase in store manager salaries to $128,000 and an increase of the bonus cap to 200% in response to a tight labour market
US health insurer Humana lowered its earnings forecast due to rising demand for medical services and higher costs after its rival UnitedHealth Group also reported a 16% rise in costs in Q3 2023 compared with the previous year
Luxury watch retailer Watches Of Switzerland issued a profit warning as consumers shied away from luxury purchases in the run-up to the holiday period
UK luxury carmaker Bentley reported an 11% fall in sales due to the state of the global economy and weak demand with sales slumping particularly in Britain, China and Hong Kong
UK supermarket lender Sainsbury’s Bank is set to exit its core banking business and instead provide financial services through third parties as the group focuses on its retail business
Google announced a $1bn investment in a data centre in the UK
US carmaker Ford announced an increase in the production of its internal combustion engine Rangers and Broncos pick-up trucks, while reducing production of the all-electric F-150 Lightning model as demand for electric vehicles is not as strong as expected
The CEO of Stellantis, the owner of Peugeot, Fiat, Opel and Citroën, warned that rapid price cuts for electric vehicles risked a “bloodbath” in the industry
In an apparent response to Western concerns about Chinese imports, a senior Chinese official said the country would rein in growth in China’s output of electric vehicles
The UK’s biggest dog rehoming charity Dog Trust reported that it is struggling with unprecedented demand as owners seek to part with their pets due to the rising cost of keeping a dog

Global and political developments

Donald Trump won a strong victory in the Iowa caucuses, cementing his position as the leading contender for the Republican nomination for president
The US Congress passed a short-term spending bill to avert a partial government shutdown, easing pressures on negotiations over military aid to Ukraine
The US conducted a fifth set of air strikes against the Iran-backed Houthi rebels in Yemen
China’s military staged its largest manoeuvres since last December around Taiwan following Taipei’s presidential election
Pakistan’s foreign ministry confirmed it successfully launched air strikes against suspected militant locations in Iran. This was in response to an Iranian missile attack against the Jaish ul-Adl group in Pakistan
The House of Commons approved the government’s Rwanda asylum bill despite resignations and attempts to toughen up the bill by some Conservative MPs

And finally… a husky potentially saved a neighbourhood in Philadelphia from an explosive gas leak. The owners of the dog, Kobe, noticed the husky digging a hole in the front garden for hours and tested the area for the presence of gas to find a major gas leak - a dog that nose its stuff

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