Inflation Could Ship the Bed

Over the last few months, we had witnessed a steady decline in inflation. There are many different ways to gauge inflation, whether you look at the CPI, CPI trim, or CPI core. It doesn’t really matter for my outlook today which inflation metric we use. Dropping inflation readings have been cheered by the government, central banks, consumers, borrowers – pretty much everyone. Inflation is coming down, and that seems to be a win. Let’s not forget though that it doesn’t mean that things are getting cheaper – simply that things are going UP at a slower speed. Not until we get DEFLATION will the prices of items actually drop. 

Pretty much everyone reading this knows that in order for the BOC to drop their benchmark rate we need to see inflation come down. So far so good, however, below I will give you a few reasons why I think high inflation may not be over. I detailed the other day why I think there is a real possibility that the BOC holds rates higher than we predict in 2024, and I think stubbornly high inflation could be one of, if not THE reason. Let’s explore.

By now everyone is acutely aware of how quickly inflation can move. While we went a little over a decade, from 2008 to 2021 with fairly beinign inflation, when it decided to rear its ugly head again – we noticed.  The BOC, and really all central banks responded in a text book fashion ( although very delayed ) and raised overnight lending rates. In economic theory if you make money more expensive, people borrow less money because it costs so much, and have less money to spend. Fewer dollars chasing the same amount of goods should slow down price appreciation due to the lack of demand. Of course theory and reality are usually a different animal, but you get the idea. There is however one other component to inflation that is a little harder to control, and that is the supply side.

Canada depends a lot of imported goods. Over the last few decades we have offshored more and more things. There is a downside to not fostering business growth and having all of your economic growth come from trading houses to everyone. When Canadians need to buy items, very little of those items are made in Canada. This means that the prices Canadians pay are subject to control outside of our borders. Things like US dollar pricing, global commodity prices ,and transportation can affect the overall consumer price of goods. You are probably aware that a large majority of Canada’s trade comes from Asia. You are also probably aware that most of the items we buy are sent via ships across a global logistical network. You may not be aware though that the global shipping industry is running into a problem in the last 10 days. 

Somali pirates are back in full force in the Red Sea, and have recently started hijacking ships traversing through the Suez Canal. The attacks and hijackings have been blamed on Somalian pirates, with links to Iran, Israel, etc. I am not going to get political here, nor even begin to think I understand the “why” behind it all. The fact remains that it is happening, and it is already becoming a problem, and could become a bigger problem. Already several shipping companies have stopped travelling through the Suez Canal, and have opted to travel around the Cape of Good hope. This adds about 15 days to the average voyage, and millions of dollars in crew and fuel costs. As of Dec 22 there were 158 vessels carrying approx 105 BILLION USD of goods on 1.2 million containers that had been re routed. Companies like IKEA, Danone, etc. have been impacted, and they are not alone. Many Canadian companies rely on efficient and affordable transportation systems to get their products to market. 

As with any type of situation, if the costs to transport something goes up, then the shipper and receiver have to pay more. To give you an example, about 3 weeks ago, the cost to move a container from Shanghai to London U.K. was about $2400.00 USD. As of 3 days ago, the price is now around $10,000.00 USD!!! That means that on that on 1 container load the pricing of the items has to go up by at least $7600.00 just to cover off the increased cost of the shipping. I say at least, because anyone who knows how margin pricing works, knows that if the item cost goes up by a dollar in cost, then the actual sale price goes up by at least $1.50 to keep margins intact. For example, if a wholesaler sells an item to a middleman for $5.00, and the middleman sells it to the store $7.50, then the store sells it for $10.00. If the wholesaler raises prices to $6.00, then the middleman ups his price to $9.00, and the retailer has to increase to $12.00. A $1.00 increase at the start of the chain was a $2.00 price increase at the end. A very simple $7,600.00 increase on 1.2 million containers works out to almost 16 billion dollars of increased costs. If retailers hold margins where they are, prices for imported goods ( which is most things in Canada ) could go up by billions and billions and billions of dollars. 

Of course there are other options like the Panama Canal, but with low water levels this season, the cost to traverse through Panama has skyrocketed, and the wait times are weeks. Adding weeks of delays, on top of an almost 2 week delay by going around, will compound the problem. Delays means that items that do arrive will be in short supply, and they will arrive with a higher sticker price. 

We all saw what happened during COVID when things were in short supply, and high demand. Could this be a repeat of COVID style pricing? I doubt it. While Somalian pirates are currently causing problems, I imagine it will be resolved within 3 to 6 weeks. When you try and hold goods for multiple nations hostage ( one of those nations being the USA ), you bring unto yourself a lot of attention, and not the good kind. Personally I would never screw around with a country who has the ability to wipe me off the face of the earth. Perhaps there are some Somalian pirates about to learn that lesson the hard way if they continue to hijack ships and caused hundreds of billions of dollars in global inflation. 

While the problem may be short lived, the issues it cause could take 3, 4, or 6 months to work there way through the supply chain. The diverted ships, and increased shipping costs will take a while to get through the system. On top of this, if there happens to be a shortage of anything, we all know what happens ( toilet paper 2020 ), and that could lead to price hikes by some not so nice retailers. Container ships that have to add tens of thousands of kilometres to their journeys will burn a lot more bunker fuel, and could put some upward pressure on oil prices.  I say all this so that you understand we could see inflation start to tick up in the first 3 months of 2024. Keep in mind it takes the BOC about 30 to 60 days to get the data, see the inflation, and react to it. 

If the Somalian pirates are brought under control quickly, this should be limited to a 60 to 90 day issue in the supply chain and inflation. However, if we try and screw around with the terrorists and let them fester on, then it could be a 6 to 9 month problem. Personally I think 2 warnings, and then deploy military assets to dispatch the bastards to the 7th layer of hell would be the way to deal with it, however, I have always lacked certain diplomacy skills.

Outside of the shipping world, we also have the date of Jan 1, 2024 coming. This date is significant because most workers get their COLA adjustment on Jan 01 of any year. Any Government payment like wages, CPP, Old Age, etc will increase by 4.80% on Jan 01. This means that anyone who has a government income ( which is basically 50% of the country ) will see an income boost of 4.80% in a week. More money coming in, chasing the same number – or potentially fewer items if the ships don’t arrive, means you get inflation. I was also speaking with someone who works for Toyota Motor Company, who is getting an $8.00 a hour raise come the new year. $8.00 an hour off of $27 to $28 last year is substantial.  I can’t imagine Toyota is the only company. If we are seeing large scale pay raises, that is as inflationary as it gets, and will cause long term inflation. 

And finally, the dollar. The Canadian dollar has been on one hell of a rip the last couple of weeks, and that will help to keep inflation down. However, if we start to see the trend reverse, and the CAD drop vs. the greenback, that will help to fan and fuel the inflationary fires. Since Canada imports a lot of their goods from the US, any increases in USD, or drop in CAD will result in higher prices to end consumers. While this appears to be on the backburner for now, anything can change at any moment. We are coming into a Presidential election year, and the current incumbent is, well, how do I say……Well, lets just say he isn’t exactly the most popular guy. He will need to do something to garner some votes, and generally anything that is pro America is a great way to increase popularity. Pro American is usually anti everyone else, so that could help to lift the USD.

Again, things could go the other way, but the case for inflation bouncing back up is certainly there, and it has one hell of a tailwind. Don’t be shocked if the inflation readings start to tick up. This will take rate drops off the table in Q1, and will probably lead to an increase in 5 year yields and by default 5 year fixed mortgages. It could take longer than expected to show up in the data too, and I look like an idiot. Luckily, I am used to looking like an idiot, and have become extremely good at wiping egg off of my face. Either way, 2024 proves to be an interesting year, and for those who can navigate the ups and downs will go all the spoils.

Stay safe, stay healthy, and I wish everyone a fantastic 2024. I hope that we are all better people 1 year from now. Worry about helping your clients, and the the commission checks will take care of themselves.