What are the elements that are crystallizing the tensions in supply chains?
There are currently four parameters that, together, are pushing tensions on supply chains to their peak.
The war in Ukraine has direct and indirect effects on supply chains. Activities in the country have come to a halt, creating a disruption in exports, particularly of manufacturing goods, mainly to Europe. German car manufacturers, who source a large part of their supplies from Ukraine, are suffering the greatest impact.
These disruptions are having a ripple effect on food items. Ukraine has massively reduced its exports, so supply is drastically reduced on several products, including wheat. These shortages are pushing other countries such as Egypt, Turkey, Argentina, or even Bulgaria and Romania, to cut their exports, by advocating food protectionism, thus accentuating the scarcity of supply for net agricultural importing countries.
Sanctions and counter-sanctions, both on Russia and Belarus, have a significant impact on all shipping. Russian ships are no longer allowed to dock in European and UK ports. In response, Russia has banned the export of 200 products, including fertilizers, cars and electronics, for example, which adds to the difficulty of global supply. As a reminder, Belarus is also one of the world's major producers and exporters of fertilizers, particularly potash.
The same goes for the issue of airspace, which once again leads to longer delivery routes, and consequently causes an increase in logistics prices, already increased by the soaring price of gasoline.
Finally, gas and oil are the focal points of the tensions. On oil, Europe is probably doing what it can to implement an embargo. It remains to be seen how many countries will be exempted, such as Hungary and Slovenia. But the continent may not have the capacity to import the equivalent of what it will not take from Russia, unless it reaches a deal with Iran and the latter resumes exports.
For its part, Russia will probably not have the capacity to reallocate this oil elsewhere. China has already taken a large share of it, and India, a candidate for purchase, will be constrained by logistical reasons. Indeed, Russian ports have limited capacity: only Aframax ships can dock there, and they are already in short supply worldwide.
Finally, if the Kremlin cuts off gas exports, many countries could find themselves in a shortage situation, especially those crossed by one of the gas pipelines. And again, there would be a ripple effect on all supply chains, whether for goods, agricultural products or energy.
The second parameter to consider is, not surprisingly, the resurgence of Covid cases in China. Currently, 30-40% of the country is under strict lockdown and air traffic is down 75% in early May on an annual basis. All ports are filled to the brim and this is creating huge delays in all supply chains, for everything to and from China.
The third parameter is semiconductor demand and supply. Despite the slowdown in growth, demand continues to explode. Graphics cards, operating systems and automobiles, for example, are demanding more and more power and capacity, and supply is not able to keep up.
There is also a "geopolitical storage" problem. Some countries, such as China, stockpile a lot of semiconductors but do not use them, or buy components on behalf of Russia, deliberately increasing scarcity. Here, the combination of parameters aggravates the situation: the blockades in China also affect several Chinese component producers.
Finally, the difficulties in the energy sector are clouding the picture. Energy producers have been reducing their capex for several years, and in some sectors, particularly fossil fuels, operating capacity is at its maximum levels.
These 4 parameters combined, added to other marginal factors, greatly complicate the environment.
How can we explain the decorrelation between industrial raw materials and oil?
On oil, there is an ongoing speculation phenomenon on the European embargo on the one hand, and on the recovery in China on the other. Today, the country is at a standstill, but as soon as Covid normalizes, demand should pick up very suddenly. China has set aside a lot of tax revenue so that once the epidemic is under control, it will be able to spend massively. Its needs will be massive.
The United States has also put large strategic reserves on the market and is now announcing that it will buy back some of them. Finally, oil supply remains very controlled, and OPEC is making little effort to produce more. Overall, supply is limited and very strong potential demand can start up again at any time.
How do you assess the situation regarding food items?
Here again, there are multiple factors. Climatic conditions are very unfavorable: the United States last year, China this winter, the Maghreb at the beginning of the year, and Europe in the spring, have experienced episodes of intense drought. Harvest quality and density are at their lowest.
Some countries are particularly to be watched. Turkey, which is facing a wheat import problem and an oil problem, intensified by a violent fall in its national currency, is likely to suffer a double whammy. Egypt, which is already in a complex economic situation, is facing food shortages.
Secondly, soaring food prices in some countries are expected to exacerbate social tensions in Sri Lanka and Peru, among others. It should be kept in mind that the current price increase is greater than the one that took place before the Arab Spring in 2011.
The situation is not expected to be resolved quickly, as prices are expected to continue to rise, as some producers have not yet passed on the cost increases.
Is there a risk of stagflation?
From the point of view of real growth, we have a very marked slowdown at the global level compared to last year. In 2021, global growth was close to 6%, but this year it should be around 2.9%, i.e. halved. We are indeed approaching zero or negative real growth, let's say on a quarterly sequential basis.
Some countries will certainly fear a recession. The United States had a negative first quarter and the second quarter will be very close to zero. In China and Europe, a sharp contraction is expected in the second quarter. But the situation differs in these regions: while the US is likely to be close to or even past peak inflation, Europe will have to wait to reach that peak. The inflation outlook remains high and may still surprise slightly on the upside, while the real growth outlook will continue to be revised downwards.
Which sectors will remain under pressure?
In construction, the impact of oil and gas is particularly noticeable, but other factors are also at play. Delivery difficulties are being felt in all regions of the world, deadlines are being extended, and some players prefer to postpone projects, which accentuates delays. Apart from big projects, it is still difficult to source materials and small elements (such as furniture, radiators, etc).
When China loosens its grip, it will want to make up for lost growth. 2022 is a crucial year for the regime with the re-election of President Xi Jinping. The country will therefore spend massively on infrastructure, and thus drive up all prices, be it cement, copper, steel, iron ore, etc. As a result, inflation is expected to remain strong in the third quarter.
Christophe Barraud joined Market Securities in 2011 and currently serves as chief economist and strategist in Paris. He has been ranked by Bloomberg as the best forecaster on U.S. statistics since 2012, best forecaster on Eurozone statistics (2015-2019) and best forecaster on Chinese statistics since 2017. MarketWatch also named him the top forecaster on US statistics in 2020. His research is aimed at a wide range of institutional investors worldwide (banks, insurance companies, management companies, hedge funds, pension funds, etc.), but also at public bodies (governments, central banks, etc.).