November 28, 2022Scroll down
It was just over a year ago that 109 ships lined up outside the LA-Long Beach port led President Biden to intervene, announcing 24/7 operating hours for the port to combat shipping congestion. Finally, we’re starting to see a decline in the backlog, in part due to inventories that have been rising since the middle of the summer. On the surface, delivery times, freight rates, and wait times have been easing, with overall indicators of shipping and supply chain stress dropping significantly.
For some time, we have been noting the importance of shipping problems as a driver of inflation. So, does this mean the global supply chain crisis is over and we might see climbing prices reverse course? Unfortunately, the easing in supply chain strain is mostly due to global demand reduction as high prices and central bank tightening take hold. Last year’s demand overshoot was driven by shoppers’ strong appetite for consumer durables after pandemic lockdowns ended, combined with long-standing inefficiencies in West Coast US ports, which remain unaddressed. The freight industry did not improve the much-needed infrastructure during the pandemic. As such, the recent reduction in port congestion and shipping costs do not in fact reflect any improvement in capacity or efficiency, and we will likely feel more supply chain pain if there is another surge in consumer demand for durable goods.
The difference between 2-year and 10-year Treasury yields, reflecting two key segments of the US yield curve, reached its largest gap since the 1980s: a deep “inversion” of the curve which stands as a classic indicator for economic downturns with a 12- to 18-month lead.
Why does the signal work? Typically, the yield curve shows an upward slope, with shorter-term bonds offering lower yields than longer-term counterparts. In most monetary policy tightening cycles, the yield on short-term bonds exceeds that of long-term bonds. That’s because when the economy requires cooling, central banks raise short rates above a long-term neutral rate to suppress demand and investment activity; and while short rates respond to Fed hikes, long rates are theoretically anchored to the long-term neutral rate, leading to the aforementioned inversion. Of course, it’s not the inversion of the yield curve itself that causes a recession but the underlying high short-term borrowing rate which may trigger one. Although short-term yield data are a bit distorted in this cycle due to historical high inflation, the market is flashing clear signs of a recession coming down the pike.
At this year’s G20 summit in Bali, leaders from both China and the US were coming off of favorable recent domestic political developments. Xi had tightened his grip on political power in China with a slate of strong allies on the government announced at October’s 20th Party Congress, while Biden and Democrats managed a surprising stand in US midterm elections, turning the expected ‘red wave’ into a ‘red ripple.’ The US election results reduced pressure on the Biden administration to effect a more hawkish China stance, and Mr. Xi’s position appeared to set him up to stabilize China’s economy with a more sustainable COVID policy. Against this backdrop, the two leaders promised to reopen some communications channels that had been placed on hold in recent years, with conversations set to restart on many topics, including a potential visit to China by Secretary of State Blinken in 2023.
Even so, US Congress remains hawkish toward China: a stance representing rare common ground between parties. One of the major risks of upsetting a thaw in relations is US legislators’ Taiwan Policy Act, which the White House has been pushing to make less provocative. Fortunately, this term’s divided Congress will likely cause fewer headaches for both the White House and Beijing on China matters.
While Mr. Biden has expanded Trump-era sanctions on China over the past two years, after his meeting with Mr. Xi, the US president noted that he ultimately seeks to avoid direct conflict with China, while staunchly defending economic competition. This tact is clearly reflected in recent US legislation on the semiconductor industry, and was also referenced in Mr. Xi’s address at the kickoff of October’s Party Congress, where he emphasized a need for technological self-sufficiency. Investors should welcome a redefinition of US-China tension as an economic competition, and will certainly be pleased if dialogue between the world’s two greatest economic powers continues to improve.