Potential economic downturn and supply chain boost collide


Subtext: Supply chains are taking a massive boost from the COVID economy and have accumulated massive inventory levels. A slowdown in consumer spending caused by inflation and a potential recession will have a massive impact on freight demand and prolong destocking.

As we watch the pandemic in the rear view mirror, the economy is moving into a new phase. With the United States currently experiencing full employment, American consumers are extremely stressed about the state of the economy and personal financial security. Inflation, collapsing stock markets, rising interest rates and economic uncertainty are undermining any confidence in full employment.

For supply chains, the consumer pushback couldn’t come at a worse time. The whiplash effect has created a massive overstock of inventory and is wreaking havoc on global supply chains as businesses try to recover from the pandemic economy.

The whiplash effect

The ‘whiplash effect’ is a term used in supply chain circles to describe a scenario in which temporary increases in retail demand are amplified and exaggerated by upstream manufacturers and suppliers, who are rapidly ramping up production well beyond the level that consumers can bear. Eventually, retailers find themselves with more inventory than they can sell, and what started as a shortage of merchandise ends up as a surplus of merchandise. If there’s a single chart that shows the supply chain whiplash effect, it’s this one:

Source: SONAR IOSI.USA (blue) IOTI.USA (green)

The graph displays an index of import shipments based on the number of bills of lading in blue and the corresponding container volumes in twenty-foot equivalent units (TEUs) in green. Both indices show how the container-to-shipment ratio has evolved during COVID.

Before COVID, the container-to-shipment ratio was quite static and the two indices moved in tandem. Starting in the summer of 2020, the container-to-shipment ratio skyrocketed as big-box retailers used their leverage to move more containers in their planned shipments. Smaller importers kept their container-to-shipment ratios more static, finding it more difficult to secure additional capacity on container ships.

This continued until the fourth quarter of 2021, when big-box retailers reverted to previous ratios, likely thinking they had enough inventory to handle demand.

At that time, if consumer demand levels had remained stable, the bullwhip effect would have occurred gradually as retailers burned through higher inventory levels over time.

But on February 24, 2022, the world completely changed. Russia invaded Ukraine. Energy and food prices soared as a result, triggering rates of inflation the Western world had not seen since the early 1980s.

As inflation continued to pick up in the spring, consumers cut spending on the very items they had previously consumed in excess. Retailers found themselves with even higher inventory levels than expected and were forced to come clean in earnings reports and subsequent public announcements.

After the first quarter 2022 results and subsequent announcements of excess inventory and slowing consumer confidence, big box retailers reduced the amount of containers per shipment. After all, why would you keep ordering more if you had more than enough in stock?

77% of U.S. container imports come from industries that reported massive supply gluts (retail, electronics, furniture, apparel and appliances). FreightWaves anticipates continued weakness until inventories return to normal levels.

Walmart was the first major Big Box retailer to report having too much inventory. The target was the second. The two Big Box retailers also happen to be the two largest importers of containerized cargo in the United States. Between them, they imported nearly 1.7 million TEUs in 2021, representing nearly 7% of all U.S. container imports.

Last week, Nikkei Asia reported that Samsung was dealing with its own bullwhip effect of too much inventory and asked upstream suppliers to cut production in half in July. Samsung was the seventh largest importer in the United States in 2021. According to SONAR Container AtlasSamsung imported 79,000 TEUs last month.

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Source: SONAR Container Atlas

According to SONAR’s Container Atlas, on May 20 the container ratio began to diverge again, this time falling below pre-COVID norms. Since then, the number of global shipments has fallen by 8% (green), while container reservations have fallen by 36% (orange).

Source: SONAR IOSI.USA (green) IOTI.USA (blue)

Big box retailers have responsive supply chains and can cancel orders quickly. Small importers tend to be slower to do so. They may not have the supply chain networks to respond to inventory issues as quickly as the big box stores, but neither do they have the leverage in their supplier networks to painlessly adjust up and down orders.

This weakness in container markets will have a significant impact on trucking in July as the container downturn hits North American ports.

Currently, the trucking market continues to weaken. This is very concerning for mid-June (normally one of the hottest months for freight). The 7-day moving average of the National Spot Index fell from $2.07/mile on June 1 to $1.96/mile on June 20.

Source: SONAR NTIL.USA

Tender rejections fell last week, hitting a new cycle low of 7.68%. Tender rejections are an indicator of trucking capacity conditions. Falling numbers indicate carriers are losing pricing power, while increasing numbers indicate carriers are gaining pricing power.

Source: SONAR OTRI.USA

Channel checks are now telling us that LTL carriers (including top performers) are starting to see a slowdown. LTL is usually the last part of the market to feel a downturn and the first to feel a recovery. LTL carriers handle smaller shipments from a broader customer portfolio than full truckload carriers, so they have more flexibility to maintain shipping volumes and asset utilization throughout the cycle.

The LTL is also more exposed to the industrial sector than the full truck. We also hear that shippers (manufacturers, distributors, CPGs, wholesalers) are seeing an acceleration in order cancellations and customer requests for delivery deferrals.

There is also a rush for temporary warehouse space. Existing inventory is not selling at expected prices, forcing businesses to find additional square feet to house newly arriving inventory. Shippers have slowed the movement of containers out of ports, resulting in longer container dwell times.

Container spot rates continue to decline and should soon fall into negative territory year-over-year. Shipping carriers have much more pricing power than truckers, but we don’t expect any increases in shipping container rates; in fact, we expect the opposite – rates will continue to fall.

The average weekly container spot rate from China to the US West Coast fell from $15,551 on April 18 to $9,177 on June 16 – a 41% drop – according to the Freightos Baltic Index.

Daily price updates, which are available for SONAR Subscribers, shows that container prices continue to fall. The updated overnight rate on the trade route from China to the west coast of North America on June 20 is $8,965.

Source: SONAR FBXD.CNAW

Fuel remains an important factor for anyone involved in the transport of goods. Diesel continues to soar and sits at $6.00 nationally ($5.85/gallon).

Source: SONAR DTS.USA

Diesel fuels the industrial economy. Freight, agriculture and construction all rely on diesel. As the price of diesel soars, it’s hurting business cash flow across the economy and making it harder for the Federal Reserve to keep inflation in check.

July and August are always slower markets for freight – the so-called “summer doldrums”. The conditions we are currently observing suggest that carriers should prepare for even weaker than normal conditions. The Atlanta Fed’s High-Frequency GDP Tracker noted the US economy is already in recession.

For freight markets and supply chains, it couldn’t have come at a worse time.

Want to stay up to date with what’s happening in the global physical economy? Check SONAR, which provides the most comprehensive high-frequency supply chain data.

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