The fight against inflation complicated by geopolitical tensions

The waters of the Red Sea have long been home to the routes of container ships and supply chains that fill our households with everyday products. The 19th century man-made Suez Canal at the north of the waterway has embedded itself as one the busiest and essential passages for the next-day-delivery world we find ourselves in. Around 12% of global trade traffic passes through the Red Sea and Suez Canal carrying a cargo value in excess of $1trillion.

Flanked by a history of civil war and political instability, the threats that lie in this stretch of sea remain well above water. One of the most critical right now being in a section called Bab-el-Mandeb, off the southern tip of Yemen. At 20km wide, it acts as a pinch point for Iran-backed Houthi rebels to wreak havoc on the transportation industry and the cargo it carries. The Houthi Rebels are acting in solidarity with their Palestinian allies at the centre of the Israel-Hamas conflict and have put a target on anybody connected with Israel, the US or UK. In response, the West continues to strike Houthi targets, attempting to neutralise the threat of continued disruption.

Whilst Maersk pulled their ships from these choppy waters, many still sailed against the potential headwinds of attack. In turn, the net has been thrown wider by the rebels and more ships are being targeted as a result of their underlying ownership. After seeing its ship, the Marlin Luanda, struck, Trafigura also diverted away in search of safe passage around the Cape of Good Hope. Container freight pricing has surged as a result of the additional mileage required to navigate around Africa. The cost of a standard shipping container from Shanghai to Rotterdam has more than trebled coming into the new year, although this remains a far cry from the peaks of the pandemic.

With the backdrop of the pandemic and supply chain nightmares still in the minds of many market participants, you would assume it could be time to batten down the hatches for the next spiral in inflation. It is without argument that these escalations bring rising costs, but to what extent will it really hurt the final consumer? Approximately 1.5% of the final price of consumer goods can be attributed to shipping, so a threefold rise here is merely pennies in the pound. The share prices of shipping companies are also welcoming the disruption due to excess capacity and otherwise empty ships being put to work. The additional fuel expense is being supplemented by the surge in freight costs and providing optimistic bottom-line numbers for those navigating longer routes.

The greater macro-economic picture is also a far cry from the height of the Covid era. This isn’t an industry-wide problem for now, and remains focussed on one key route to the European market. What should be noted are the second order effects that could unfold should the threat of instability become more widespread and break out. These knock-on effects may be harder felt on the eastern side of the pond with Europe relying heavily on the Red Sea being an accessible path for trade. ECB President Lagarde has been vocal about her concerns regarding potential supply chain bottlenecks – even highlighting them as one of her four key risk factors in the fight against inflation.

It’s also hard to look at past geopolitical instability and leave out the volatility that is often felt within oil prices. Of late, small directional movements from headlines have seen for some choppy action. Yet the concern has been underwhelming and if anything, sideways - emphasising the lack of market panic regarding the events unfolding.

There is no good time for geopolitical instability because it can be bad for trade all around. Despite this, we find ourselves in a period where stock markets are stalking record highs, and the economy is displaying undeniable resilience. For now, the conflict and attacks feel self-contained and, as such, economic risks are rightly sidelined. Yet central bankers’ mood to keep this point prevalent and in the public eye highlights the risks that we could see play out should their attention turn towards the side of caution. The fight against inflation is ruling the bets on rate cuts – with the market consistently pricing them in as central bankers find every tool in their arsenal to rule them out. Ongoing conflict in the Red Sea may be a reason for some policymakers to err on the side of caution as they hold their stance for longer. These troubles are anything but dead in the water, and policymakers will be keeping a firm eye on whether it forces inflation to walk the plank.