Chart of the Week : The supply chain is a big mess and the Fed cannot do anything to change this

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The global economy is facing at least four major shocks : 1) the Ukraine war which increases the risk of a recession in Europe this year (but we don’t forecast the eurozone economy will enter in a recession in 2022) ; 2) tighter U.S. financial conditions that will choke off the housing market ; 3) China’s lockdowns that will cause Q2 Chinese GDP to contract and ; 4) persistent supply chain disruptions resulting from a combination of factors (extreme weather in India/Pakistan, lack of containers, China’s zero Covid policy which may last at least until the congress of the ruling Communist Party in the autumn, high transportation and energy costs etc.).

For years, global growth has been a function of the inflow of liquidity and credit into the economy, mostly driven by quantitative easing and other ultra-accommodative monetary policies. Now, global growth is a function of the availability of real things such as diesel, electricity, natural gas, fertilizers, grains, copper, nickel or lithium. Basically, things that central banks cannot print. This is rather unusual. This will last.

Take container ships : a fifth of them are currently stuck in congested ports, partially due to China’s lockdowns and new shipping capacity has yet to be built (source : The Maritime Executive). Don’t expect any long-lasting improvement in the supply chain before 2023 at best when new containers will likely arrive in the market. This will reduce congestion, hopefully. In the interim, lingering supply chain difficulties will continue to weigh on economic activity. In the below chart, we show expectations of unfilled orders by manufacturing firms from the Philadelphia region (access to the full survey here). In May, the index for expected unfilled orders decreased from minus 13.4 to minus 24.5. This is a record low since March 1995 (it was at minus 27.8). Firms consider that China’s lockdowns combined with the shortage of inventories will negatively impact U.S. industrial production in the short- and medium-term. We observe similar trends in several other U.S. regional manufacturing surveys. Future unfilled orders are also in negative territory (minus 2.6) in the region of New York in May, for instance.

Despite an easing in restrictions in Beijing since yesterday and in Shanghai from 1 June onwards, global trade congestion continues to cause backlogs and higher inflation across the board. Due to Shanghai's lockdown, up to 260,000 twenty-foot equivalent units (which is a commonly used measure of volume in units of twenty-foot long containers) could not leave the port of the city in April. This will take weeks to ship, probably between 8 to 10 weeks according to our own calculations. This will imply higher transportation costs too. Neighboring ports are also highly congested, such as the port of Ningbo-Zhoushan (busiest port in the world in terms of cargo tonnage) where a large number of containerships have been diverted away from Shanghai in recent weeks. Traffic on the Asia-Europe route is particularly slow now. The average delay of container ships doing a complete rotation reached an average of 20 days in May, compared to 17 in February according to the online liner shipping solution Alphaliner. Port delays are increasing a lot in Europe, where ships must await berthing before docking. This ultimately increases bottlenecks. Expect the situation to worsen in the very short-term as a new wave of Chinese exports looms with the reopening of the economy. This means that the bottom has certainly not been reached yet in the below survey. The index for expected unfilled orders is likely to move lower in June and in July, at least. We need to understand the global supply chain is a big mess and the Fed cannot do anything to change this. Bottlenecks are here to stay. This is certainly an over-optimistic view to believe that inflation can be put under control just by raising interest rates for several months in a row.