Worries, Realities and the Red Sea
What happened last week?
- The S&P 500 rose 1.17%
- The Dow Jones gained 0.72%
- The Nasdaq advanced 2.26%
3 Things to Know
Bonds Reprice as Equities Shake off Geopolitical Risks
Since peaking at over 5% in late October 2023, 10-year US Treasury (UST) yields have fallen on lower inflation readings and a less hawkish Fed as we said earlier. After the New Year, bullish economic data and a realization that a March rate cut was uncertain initiated market reversals.
The S&P 500 fell roughly 2.5% the first week of 2024 before closing at a record high last week.
The combination of both strong economic data (higher long-dated yields) and Fed easing (lower short-rates) has driven a bull steepening of the US Treasury curve that has been inverted since mid-2022.
In fact, US 2s10s curve traded this week at the “least inverted” it has been for the entire cycle. This is a very welcoming sign and is consistent with the guidance in our 2024 Wealth Outlook regarding moving out of money markets and into the intermediate part of the yield curve.
A Major Artery of Global Trade Is Now Blocked
The World Economic Forum estimates that 90% of all international trade is transported by the sea and the Red Sea stands as a crucial artery, connecting the Mediterranean and the Indian Ocean. According to the Suez Canal Association, approximately 12% of global trade traverses through the Red Sea. Off the coast of Yemen, the Red Sea narrows to a choke point, just 14 miles wide at Bab-el-Mandeb.
A recent IMF paper presented to the World Bank has estimated the impacts of increases in shipping costs on inflation in different regions of the world. The authors reported that a one standard deviation increase in shipping costs boosted inflation globally by about 0.1 percentage points, but that the variation between nations was extreme, with poorer countries and island nations experiencing much larger impacts.
For those shippers that wish to avoid the Red Sea, there are two options: either wait and hope the situation improves or undertake the long trip around the Cape of Good Hope. The latter option doubles the shipping length and time.
The initial market response to the October 7th Hamas attack was a large increase in both Baltic dry and wet shipping costs. Subsequently, the dry container shipping prices rapidly normalized, while the dirty wet shipping of crude oil have continued to rise.
At the same time, the price of Brent crude oil has actually fallen since the later Red Sea conflicts erupted. In an age of Artificial Intelligence, one rarely considers the size and frequency of passage by the enormous ships traversing Canals dug in the middle of the 19th century.
But the share of global trade that is carried by ship is continuing to increase, not decrease, over time.
The tight trade relationships between Asia and Europe will face greater shipping costs from the longer container routes, putting greater pressure on export-heavy countries. And while the US receives the bulk of its trade goods from Asia across the Pacific, as much as 30% of shipping to the US East Coast does pass normally through the Suez Canal.
The Impact Is Expected to be Modest Despite the Headlines
Despite the importance to global trade of the Red Sea, we expect the final impact on consumers and markets around the world to be modest, in the aggregate.
As we have written before, most geopolitical crises do not have durable market impacts including, for now, the war in the Middle East.
While there is increasing risk of a broader Middle East confrontation, the current outbreak of fighting between the US, UK and Yemen is limited. Meanwhile, the flexibility of supply chains and the adaptability of markets is evident in the pricing of goods in spite of materially higher shipping costs.
If the current conflict expands, it could pose a setback for global progress on inflation, especially in Europe.
However, the disruptions to date should not significantly alter measured inflation in the US and is unlikely to shift the favored easing course of major Central Banks
See our weekly CIO Strategy Bulletin for more details