Disruptions to global supply chains in the more than two years of the pandemic have led the way for inflation to soar across much of the world, forcing major central banks such as the Federal Reserve (Fed) to abruptly shift their policy stance: from low interest rates and market-supportive quantitative easing to vigorously raising borrowing costs and winding down trillions of dollars in asset purchases.

Lending a hand to elevate inflation to the highest level in 40 years in the United States was a surge in pent-up consumer demand for manufactured goods, primarily from China, amid social sequestration and lockdowns to contain the pandemic during the early days that kept large segments of the population from such simple pleasures as dining out or going to a concert.

The combination of the two factors – supply chain disruptions and a switch in demand from services to manufactured goods – saw headline inflation in the U.S. soar past 9% in June 2022 before easing to 8.5% in July from a year ago. Stripping away the volatile food and energy components, core inflation as measured by the Personal Consumption Expenditure (PCE) eased to 4.6% from 4.8%.

So, has there been any improvement to the supply chain dilemma? Yes, at least by one critical measure – shipping costs, which are a major component of the eventual price consumers pay at retail stores.

Figure 1: Shipping Costs are Falling to Near Pre-Pandemic Levels

Freight rates along major global routes have fallen sharply over the past six months in an indication that the surge in demand for manufactured goods made in China could be easing, and that there is less of a congestion of vessels at ports waiting to load goods for world-wide distribution. Tight supply of vessels due to port congestion contributed to the rise in freight charges during the peak pandemic period.

Costs to ship goods in 40-ft containers from Shanghai to Los Angeles have tumbled from a peak of $12,000 at the end of 2021 to around $6,000 as of this writing – a staggering 50% decline within a period of about six months (Figure 1). Rates averaged around $1,500 until the end of 2021 when first word of the pandemic appearing in China began to spread across the world. From June 2021 through the end of 2021, rates rose exponentially to over $10,000 per 40-ft container.

Some of the primary U.S. imports of Chinese products in 2021 include electrical and electronic equipment, machinery, toys, furniture and plastics. During the height of the pandemic, there was a noticeable increase in home remodeling in the U.S., with materials derived mostly from China.

Steady rise in recreational spending

There are also indications of shifts in consumer spending, which accounts for nearly 70% of economic activity in the U.S., with the easing of pandemic restrictions and the resumption of public activities such as outdoor music concerts, baseball games and eating out. Just before news of the pandemic broke in late 2019, recreational spending in the U.S. was around $60 billion in January 2020. This plummeted to $24 billion in April of 2020 as the pandemic began to take hold, before recovering to a peak of $50 billion in June 2021. By July 2021, consumer spending in this category came bouncing back, standing at $58 billion, but still lagging the high set in January 2020 (Figure 2).

Recreational spending is expected to keep rising in keeping with the trend, and also amid a more than 5% a year increase in hourly wages due to a tight labor market. There are currently two jobs available for every unemployed worker, with the total number of available jobs topping 11 million.

Figure 2: Spending on recreational activities is on the rise

Overall consumer spending on goods rose steadily from the early days of the pandemic, from $4.56 billion to above $5 billion in January 2021 to peak at $5.97 billion in June, before easing a touch to $5.96 billion in July, according to data from the Bureau of Economic Analysis (Figure 3).

Figure 3: Consumer spending in a bedrock of the U.S. economy

For services, consumer spending rose to $10.04 billion in April 2021 from a year ago, hitting $11 billion in April of 2022 and reaching $11.2 in July of this year.

Consumer spending has been robust despite the surge in inflation, with the Fed reiterating its commitment to beating back elevated consumer prices to its target 2% by continuing to raise rates, dousing expectations for any rate cuts in 2023. The Fed has already raised rates four times this year, taking short-term lending rates to 2.25% to 2.50% from near zero in March. Fed fund futures, the implied rate for overnight loans banks charge each other from reserves deposited at the Fed, are expecting the Fed to raise rates by 50-75 basis points at its policy-setting meeting on September 20/21. The tight labor market situation has strengthened the Fed’s hand despite a slowing economy.

Another measure of shipping costs slides

While there has been a marked decline in the shipping costs for containerized imports of consumer goods, there has been an even bigger slide in freight rates for transporting a range of bulk commodities. The Dry Bulk Index, a composite of three sub-indexes covering Capsize, Panamax and Supramax-sized vessels that ferry commodities such as coal, iron ore and grains, has tumbled about 80% from a high above 5,500 points late last year to around 1,000, the lowest level since around June 2020 (Figure 4).   

Figure 4: Shipping costs for goods such as iron ore and coal have tumbled

The Panamax-sized vessels, which are the primary vessels in shipping U.S. grains across the globe and in particular to China, has seen values drop significantly (Figure 5). The index is around 1,500 points, down from its 2021 peak above 3,500. China’s economic growth slowed to a trickle at 0.4% in the second quarter after expanding 4.8% in the first three months amid its strict zero-Covid policy and trouble in the country’s property sector. Beijing has cut key lending rates three times this year and introduced a slew of fiscal stimulus programs in a bid to bolster growth and achieve its target of 5.5% growth in 2022.

Figure 5: The cost to ship grains in Panamax-size vessels has tumbled

China is a major importer of a range of commodities, from metals such as copper, to grains and oil, and as such its demand is crucial to these markets. The slowing pace of growth has already caused prices for a variety of commodities to come off their peaks. Copper prices, considered a barometer of global growth, are down 27% from their highs of March 2022.

China remains the top export market for U.S. soybeans, but sales were about 17% lower in the just ended 2021/22 marketing year (Sept/Aug) from the previous season, according to data from the U.S. Department of Agriculture. Similarly, China’s purchases of U.S. corn in the current market year was lower, down 35% from a year earlier, according to the government data.

Any further slowdown in China’s economic growth could have significant implications for commodity markets, including grains, oils and metals.

Bottom Line:

  • China-US shipping costs well below pandemic peak
  • Supply chain disruptions, consumer demand elevated inflation
  • U.S. recreational spending has been on an uptrend
  • Slowing growth in China could impact commodity prices

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