By Recent attacks by Houthi militants in the Red Sea have raised concerns about a potential surge in inflation. However, experts on Wall Street argue that these fears may be exaggerated unless tensions escalate significantly.
According to Dario Perkins of TSLombard, the connection between increasing freight costs and rising consumer prices is relatively weak, particularly for developed economies like the U.S. In fact, when compared to other developed and large emerging-market economies, the U.S. has remarkably low freight costs as a percentage of GDP.
Various studies have attempted to establish a correlation between rising freight costs and the Consumer Price Index (CPI), with one of the most comprehensive being commissioned by the International Monetary Fund.
To accurately assess the impact of rising freight costs on inflation, Perkins emphasizes the need to determine the share of imports in the CPI and then calculate the proportion of freight costs within those imports.
Based on these factors, it appears that small island nations will experience the most significant price shock due to trade disruptions. On the other hand, the U.S. could see a potential increase of 0.4% to 0.7% in headline CPI. The impact on core CPI is expected to be smaller, at around 0.2%.
While the situation in the Red Sea is a contributing factor to discussions around inflation, it is not the sole concern in play. Christopher Smart, managing partner at Arbroath Group and former chief strategist at Barings Bank, highlights that historically low water levels caused by El Nino have restricted shipping traffic through the Panama Canal.
After a rough estimate, Smart concludes that the inflationary impact of the Panama Canal situation is likely to be insignificant.
Canal Shipping Costs Have Little Impact on Final Prices, Says Expert
According to industry expert Smart, even if canal shipping costs were to double for an entire year, the effect on final prices would be negligible. He further emphasized that one-year inflation breakevens have actually declined since December, indicating a decrease in investors’ expectations for inflation one year from now. The latest estimate puts the expected year-over-year inflation rate at 2.43%.
Smart advises against worrying about consumer price index (CPI) and instead directs attention to more pressing matters such as the loss of allied Navy SEALS in combat with the Houthis, potential escalation of hostilities in the Middle East, and the enduring costs of climate change and weather damage.
As for the Federal Reserve’s response, Perkins suggests that they are likely to overlook any supply shock, particularly because U.S. freight costs have not experienced significant increases as shown in the provided chart.
Thankfully, the impact of recent attacks on shipping vessels in the Red Sea has been minimal. The yearly rate of core inflation, measured by the Fed’s preferred inflation barometer, the PCE gauge, decreased to 2.9% in December from 3.2% the previous month, marking its lowest level in nearly three years.
On Wall Street, investment-bank strategists at Goldman Sachs Group have upheld their forecast regarding the number of interest rate cuts by the Fed in 2024. They reaffirm their belief that interest rates will be cut five times this year, with the first cut anticipated after the Fed’s March meeting.
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