How do supply chain disruptions contribute to inflation?

Since product shortages arose in the wake of the COVID-19 pandemic starting in 2020, the supply chain of goods has drawn more investor attention. In the global economy of 2024, supply chain issues are generally isolated, but events continue to call attention to potential vulnerabilities.

Among the most recent developments that raised concerns is the tragic event in Baltimore, a major east coast shipping port, when a large container ship collided with the Francis Scott Key bridge, causing its collapse, and resulting in six deaths. With debris remaining in the water for an extended time after the accident occurred, shipping traffic was curtailed. It created a bottleneck for goods waiting to be loaded onto ships already in the port and prevented other ships from coming in to the harbor to unload goods. Traffic and goods had to be diverted to other east coast ports.

“In the initial days following the accident, while it is leading to some isolated challenges, the lack of access in and out of Baltimore’s port does not yet seem to have affected prices and the broader supply chain,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management.

The events in the U.S. come in the wake of additional shipping challenge occurring in the Middle East. Among the repercussions from the current Israeli-Hamas conflict are attacks by Yemeni-based Houthi militants on cargo ships using the Red Sea to move goods, particularly oil. These actions forced several cargo ship operators to suspend Red Sea operations over fears of possible attacks. Instead, operators are diverting to longer routes, which could delay the delivery of goods. In the meantime, the U.S., Britain, and other nations are using military resources to try to protect shipping in Red Sea lanes, so far with mixed results.

“The Red Sea is important for moving oil, particularly to Europe,” says Haworth. “It’s possible the disruptions caused by the Red Sea threats to shipping are contributing to the recent upswing in oil prices.” Markets may also be concerned about the possible impact on oil prices should the scope of the Middle East conflict widen.

Energy price drops played a major role in inflation’s decline from a peak of 9.1% for the previous 12-month period as of June 2022, to 3.2% for the 12-months ending in February 2024, as measured by the Consumer Price Index.¹ However, inflation has lingered above 3% since 2023’s summer months, and the recent oil price rise is likely contributing to persistent elevated inflation.

Will supply chain issues again become a flashpoint for the markets given the ongoing conflict in the Middle East and other potential issues?

Evolving supply chain concerns

Potential supply chain issues in 2024 differ from what initially sparked inflationary concerns in 2021. At that time, pent-up consumer demand spiked following the economy’s “shutdown” phase, due to the COVID-19 pandemic. As consumers ramped up spending, supported by emergency government support programs to households and businesses, the global economy faced a shortage of commodities, parts or products that resulted in a supply-demand imbalance, forcing prices higher.

“Higher inflation reflected a restricted supply of goods at the same time that there was strong demand for many of those same goods,” says Tom Hainlin, national investment strategist at U.S. Bank. Energy and food products were leading drivers as inflation soared. The war between Russia and Ukraine, for a time, interrupted some shipments of energy and agricultural commodities from both countries. China's COVID-19 lockdown policies, which were in place until late 2022, hampered manufacturing and shipment of goods from Chinese firms.

Yet supply chain issues affecting a wider range of products also contributed to the problem. Some companies had difficulty keeping up with demand, sourcing components needed to manufacture products or finding enough workers to fill production needs. In addition, transportation challenges arose, including a backup of shipping traffic in some ports and a shortage of truckers to haul freight over long distances.

For the most part, the worst of these challenges have subsided. Manufacturer supplies improved and consumers are finding most goods readily accessible. The economy also transitioned from one driven by demand for goods to increased spending on services, including travel and entertainment.

“Goods demand flattened out beginning in 2022,” says Haworth. “Inflation today is much more visible for services than for goods, based on recent Consumer Price Index data.” The slowdown in the growth of goods demand has put less stress on supply chains. “Durable good sales are also affected due to higher costs of borrowing to purchase big ticket items like automobiles,” says Haworth. Tempering demand to cool inflation was part of the Federal Reserve’s strategy in raising the federal funds target rate it controls eleven times in 2022 and 2023.

Chip shortage

Another prominent story related to supply chain issues was the so-called “chip shortage” referring to a lack of semiconductor components. Chips are used in virtually every digital electronic device today. Dating back to late 2020, a backlog of chip orders led to a shortage of many products including automobiles. Higher costs for new and used cars were another major contributor to the rapid increase in the overall inflation rate. Supplies of chips began to improve in 2022, due to a combination of increased production and a slowdown in sales of personal computers, smartphones and consumer electronics.² That helped ease price pressures.

The new CHIPS and Science Act incentivizes construction of domestic semiconductor manufacturing plants. It includes a federal government commitment of $52 billion to support the development of the domestic semiconductor industry. “Government backing of new semiconductor plants is more of a long-term solution,” says Haworth. “It will take three-to-five years for these facilities to be online, so it doesn’t solve any immediate supply concerns should they arise.”

Labor shortages and other challenges

Some issues may persist because there are not enough workers to fill available American jobs. “While supplies and transportation hubs seem to be keeping pace these days, labor shortages may be the biggest issue affecting the supply chain,” says Haworth. Based on recent jobs data, approximately 1.4 positions are open for every available worker, demonstrating a need for more workers to fill available jobs.³

In today’s environment, unemployment lingers near historic lows and job openings remain high. “The major challenge for many employers is whether they can attract and retain sufficient quality labor to meet their production demands,” says Hainlin.

Where we go from here

The Red Sea attacks on cargo ships and the shutdown of Baltimore’s port are only the most recent challenges facing supply chains. While these events add to specific supply chain concerns, there’s no clear impact on the broader inflation rate. The Fed remains focused on bringing inflation down to its target range of 2%, well below the current levels exceeding 3%. The Fed has signaled it could begin cutting the fed funds target rate in 2024, although the timing of the first rate appears to be several months out.

Despite higher interest rates, the U.S. economy demonstrated resilience in 2023, avoiding a recession. The economy grew by about an annualized rate of about 2.5% in 2023, an unexpected improvement on 2022’s growth rate of 1.9%.⁴ Persistent consumer demand and a strong job market greatly influenced economic growth. Investors will continue to monitor these data points in the months ahead to determine the impact on corporate profits and stock prices.

Talk with your wealth planning professional to determine how economic developments such as inflation trends may impact your own investment strategy and your long-term financial goals.