A New Quarter: More of the Same?
It is difficult not to get caught up in the general feeling of doom and gloom when it comes to the global economy. War in the eastern parts of Europe, an increased risk of renewed Covid-restrictions in China, rapidly rising inflation and a brewing energy crisis in Europe are some of the factors that contribute to the increasing headwinds that the global economy is facing.
However, the year started differently. After an extended period of Covid-related disruptions, the new year provided some promises of a return to something that resembled normality for the commodities and dry bulk freight markets. In the last few years, the markets’ traditional seasonal patterns have been largely absent. Still, with the global economy emerging from the clutches of the pandemic and a popular narrative of a commodities super-cycle, it was widely expected that this year would mark the end of disruptions. However, the Russian assault on its western neighbour, followed by an extensive breakout of the Covid-virus in China and renewed lockdowns, effectively ended any such notions. Shipfix’s cargo order data for the first half of the year highlight a brief recovery in volumes following the Chinese New Year, but it proved short-lived, and the monthly data has been trending lower since in contrast to standard seasonal patterns.
Rising energy prices in the wake of the supply disruptions caused by the Russian invasion and subsequent sanctions contributed to soaring inflation globally. However, an extensive build-up of debt amid governmental support measures during the pandemic and long-running quantitative monetary easing had already built much of the foundation for the current inflationary pressures. The ever-increasing inflation rates and, more worryingly, higher expectations of future price rises will force many of the world’s central banks to adopt a more hawkish stance as they try to achieve the coveted soft landing of the economy. However, it is looking increasingly unrealistic that controlling inflation rates will come without any greater costs to the global economy. Wednesday’s release of US inflation data for June highlighted the challenges ahead. At 9.1 per cent, the year-on-year increase was the highest since the first year of Ronald Reagan’s presidency more than four decades ago. Several economists tabled the suggestion that the next Federal Reserve meeting could conclude with interest rates going up by one percentage point as a result of the higher-than-expected reading.
Such a rapid increase in US interest rates is likely to fuel a more robust dollar because of the growing interest rate differential with the rest of the world. Hence, the rest of the world may end up paying more for dollar-denominated commodities in their local currencies, further fuelling inflation and potential demand destruction. The recent US interest rate hikes, and the prospect of more to come, have already propelled the dollar, versus a basket of currencies, to the highest level since the second quarter of 2002. Given that most central banks outside of the US are adopting a more measured approach to hikes, the dollar looks likely to continue to appreciate. In addition, the increasing allure of the US dollar as a safe haven amid high inflation will strengthen the currency and make commodities more expensive in local currencies, effectively exporting US inflationary pressures and reducing demand through higher costs. However, the rest of the world may be forced to ramp up their efforts as the stronger dollar may provide additional fuel for local prices, especially for energy.
It is often said that inflation is good for commodities and shipping, with both asset classes popular as hedges against high price levels. The assumption behind this argument is that commodities and vessels are real assets with finite supplies, and the relative loss of value of money through inflation would force prices higher. If prices remained unchanged, it would mean that commodities and vessels are losing value in real terms, and demand would increase. Hence, market prices would be forced higher as supplies are finite. However, the argument may struggle if the inflation rates remain as high as they currently are, as they are more likely to lead to global demand destruction instead. Higher interest rates will weigh on investment activities. At the same time, the soaring prices will reduce real incomes globally, with both factors likely to inflict some damage on the demand for commodities and seaborne transportation.
The increasingly dubious outlook for the global economy has taken its toll on the commodity prices in recent weeks, with both Brent and iron ore futures contracts trading around 100 dollars. Copper, the traditional bellwether for the global economy, has sunk to the lowest levels since November 2020. Only natural gas and coal have bucked the trend amid tight supplies and distribution disruptions. However, it would be a mistake to use falling commodity prices as a guide for the direction of dry bulk freight rates. Commodities and shipping have got their own sets of supply and demand dynamics, with freight rates dependent on commodity volumes shipped rather than prices. In addition, commodity futures have lost their allure as a proxy for Chinese growth, and a lot of liquidity has left the market, providing additional downward pressure on prices.
Dry bulk freight rates could get some support from government initiatives to support growth rates, most notably in China. There are reports that the Chinese government is preparing to make the equivalent of 1.1 trillion dollars available for infrastructure investments to support the economy in the wake of the extensive damages caused by the lockdowns during the year's second quarter. If it comes to fruition, it will mark a significant policy reversal for Beijing, where debt control has recently been on the top of the agenda. In addition, the infrastructure investment plans that the US administration put in place to help the country emerge from the clutches of the pandemic will also have lasting effects on the US demand for dry bulk commodities. Despite the US economy facing increasing interest rates and more expensive investments, the country’s imports of cement, an essential building material, look set to rise. Shipfix cargo order data point toward increasing volumes discharged in US ports in the coming months.
An extensive Chinese drive to invest in infrastructure projects would promote the demand for many dry bulk commodities, notably iron ore and copper. The red metal has seen its fortunes under pressure in the last few months amid weak Chinese demand during the recent lockdowns. Cargo order volumes for copper heading for China have been trending higher since the middle of April, providing some support for the notion that the Chinese economy is recovering, albeit slowly. However, the past two weeks have seen volumes collapsing, possibly reflecting concerns over rising Covid-infection rates and renewed lockdowns. A successful implementation of the reported stimulus programmes would nevertheless see the volumes regaining their positive momentum.
The first half of the year provided limited support for traditional behaviour for the dry bulk freight rates and commodity prices, with the seasonality absent. The first tentative steps into the second half have not offered much reason for a change to the narrative. The increasing likelihood of a recession, or at least weaker growth, will dim the demand outlook for many dry bulk commodities. Coal will remain an outlier, with demand likely to continue to grow as Russian natural gas supplies remain unreliable for European buyers. Hence, any major investment drive initiated by the Chinese authorities will be much appreciated by the dry bulk shipowning community. However, unlike previous economic downturns, the traditional bust in the dry bulk sector is unlikely to be repeated, thanks to prudent new-ordering activities in recent years.