Assessing fitness for winter’s horizon

The most recent US focused Logistics Managers’ Index (LMI) offers a potential inflection point.

In August the Logistics Manager’s Index read in at 51.2. This is a marked change for the index as before August’s reading the overall index had registered three consecutive months of contraction and five consecutive months of registering new all-time low scores. In contrast, this is the fastest rate of expansion since February. The expansion this month is driven by increased activity across all eight sub-metrics of the index. Inventory Levels are still contracting, but at a much slower rate (+6.0) than July’s reading of 41.9, which was the steepest rate of contraction in the history of the index. This has led to an increase in Inventory Costs (+8.6 to 69.1) and Warehousing Prices (+2.8 to 63.4). We also observe Transportation Utilization moving out of contraction (+8.2 to 50.0) and the rate of Transportation Price contraction slowing considerably (+7.3 to 42.9).

Will this change in direction persist?

The more expansive Global Supply Chain Pressure Index (GSCPI) — that seemed to have bottomed out in May — has spent July and August idling at almost one standard deviation below long-term-average performance. Will pressure build or leak as we head into the Northern Hemisphere’s winter?

Especially when more comprehensive measures, such as the LMI and GSCPI, are not readily coherent, I find it helpful to follow some other measures. This spring and summer I have tried to tracking the following five:

North American Agricultural Production: The September 14 USDA Wheat Outlook reports:

U.S. Hard Red Winter (HRW) exports are forecast down 10 million bushels this month to 155 million bushels, the lowest since records started in 1973/74. HRW supplies have seen a long-term downturn in U.S. acreage as corn and soy have gained acreage in many locations. At the same time, international wheat competition has surged, resulting in exports of this class being less competitive on the global market. Recently, U.S. HRW supplies have been affected by drought in consecutive years, which has dented crop prospects and contributed to exports of this class being uncompetitive with other suppliers such as Russia and the European Union (EU). Historically, HRW was the leading class of U.S. exports, but in this season, it is forecast as the third largest class of U.S. exports, being surpassed by both Hard Red Spring (HRS) and White wheat (figure 1). Production of HRS and White are down year-over-year with lower yields, but drought has not affected those classes to the same extent as HRW.

The September 12 USDA World Agricultural Supply and Demand Estimates (WASDE) reported on the wheat crop, “Supplies are projected to decline 7.2 million tons to 1,054.5 million, primarily on lower production for Australia, Canada, Argentina, and the EU, which is only partly offset by an increase for Ukraine. If realized, this would be the first year-to-year decline in global wheat production since 2018/19. Australia is reduced 3.0 million tons to 26.0 million as dry weather this past month in Western Australia, New South Wales, and Queensland lowers yield prospects. Canada is decreased 2.0 million tons to 31.0 million on the initial model-based forecast by Statistics Canada for the 2023/24 crop, indicating lower yields from last year arising from dry conditions across the Prairies.” (More and more and more).

Global Natural Gas Demand and Supply: US domestic and export flows have been strong, at least prior to last week’s problems at the Freeport LNG terminal (more and more ). US exports combined with with outbound flows from Norway, Qatar, and Algeria have been sufficient to ameliorate recent concerns regarding Australia’s LNG exports. But Freeport’s troubles coinciding with Australia’s labor issues (and more) contributed to last week’s upward movement in the benchmark EU natural gas price. According to CNBC, Ana Maria Jaller-Makarewicz, energy analyst at the Institute for Energy Economics and Financial Analysis offered, “Gas markets are becoming riskier — gas and LNG prices are increasingly volatile and greatly affected by global factors… The uncertainty of future events that could affect gas supply makes it extremely difficult to predict how the supply and demand could be balanced and how much prices could escalate by. As seen in last year’s events in Europe, the only way that importing countries can mitigate that risk is by reducing their internal consumption.” In most of the EU demand and consumption of natural gas has been reduced by almost one-fifth multi-year averages. According to Reuters, “Gas imports into Germany dropped 17.9% year-on-year in January-August 2023…” Conservation has combined with a slowed economy to constrain natural gas consumption. In East Asia demand has been “tepid” for most of this year. US demand for natural gas has, however, been record-setting, largely due to electric power sector consumption in response to record summer heat.

China Export Volumes and Value: The Wall Street Journal reports that when valued in US dollars, “China’s outbound shipments declined 8.8% in August from a year earlier, China’s General Administration of Customs said Thursday [September 7]. The reading narrowed from the 14.5% year-over-year drop in exports in July, which marked the worst such result since February 2020.” (More and more). In July Mexico replaced China as the largest source of US imported goods. This reflects a sustained decline in US-China bilateral trade and shifts in China’s outbound velocity. The ASEAN region now claims more of total China trade (imports and exports) than either the United States or European Union. For August 2023 China’s dollar-valued exports to the US totaled $45,032 million, exports to ASEAN totaled $42,866 million, and exports to the EU $41,295 million. The South China Morning Post reports, “While China has long been Asean’s biggest trading partner, Asean only became China’s biggest trading partner in 2020 – filling a position long held by the US. Since 2018, when the trade war broke out between the world’s two biggest economies, changes in the supply chain have seen Beijing step up trade with its neighbours as manufacturers shifted from China to Asean countries. China-Asean bilateral trade grew from US$641.5 billion in 2019 to US$975.3 billion in 2022” (more and more). Bloomberg reports, “… parts sourced from China are increasingly moving to Southeast Asia for final assembly before being exported to the rest of the world…”

North American Grid Capacity: In early Spring this measure was selected because of concerns for getting through the Summer without major grid failures. We have had too many close calls (here and here and here), but the near-term worst is now probably behind us and longer-term trends are encouraging. The strategic risk involves 1) demand-spikes from extreme weather, especially in places with 2) rapidly increasing long-term core-demand where local generation capacity is challenged to grow fast enough, and 3) the ability when necessary to complement local generation capacity with effective transmission of wider-area — even continental — generating capacity. Wherever two or three of these factors gather together problems can (too) quickly trip into crisis. Extreme winter weather will increase prospects for this three-headed hydra. These risks are likely to persist for at least another decade in places with rapid population growth. But the North American grid is also experiencing significant capacity upgrades (here and here and here). But the transmission network to deliver this new capacity to demand is not expanding quite as quickly (here and here and here). The next few years will be dicey, but the problems are finally widely recognized, significant investments are being made, and — maybe — a shared sense of practical urgency has emerged (here and here and even here at this blog).

US Personal Consumption Expenditures: At the end of August the Bureau of Economic Analysis gave us this angle on July economic activity: personal income increased $45.0 billion (0.2 percent at a monthly rate). Disposable personal income (personal income less personal current taxes) increased $7.3 billion (less than 0.1 percent). Personal consumption expenditures (not inflation-adjusted) increased $144.6 billion (0.8 percent), see chart below. This level of spending generates strong corporate balance sheets, but over time has the opposite effect on personal financial conditions. Pandemic-related forced savings and wage increases have fueled several months of increased personal expenditures but the surplus is almost gone (here and here). How quickly and how much this pull will shift is now a crucial question. Will wages leap higher? If so, how much will inflation eat away the increase? Or how many jobs will be lost as interest rates rise to dampen inflation? If fuel costs continue to increase (see above) this will increase costs and prices across sectors. How will PCE adapt? Who will win? Who will lose? How will push respond to these changes in pull?

With many local exceptions, it seems to me that push and pull have been basically in balance for most of this year. Despite droughts, war, and more, food remains abundant — if a bit less abundant than in some prior years. For most of the last year global energy stocks have also been abundant, more abundant than reasonably feared, and prices have been moderate. There are now increasing pressures — some intentional and some not at all — to constrain energy flows in a manner that tends to increase prices. Marginally increased prices for fuel, food, and more have, so far, softened demand more successfully than spurred increased wages. In the late-pandemic period and since, European and East Asian consumers have been restrained. Even US consumers have reduced their rate of increased spending when adjusted for inflation (see red line in chart below). Upstream production capacity has mostly been preserved (and even expanded), but actual push has slowed to better match current pull. This balance can be treacherous in case of any sudden, unexpected spike in demand or when midstream channels are insufficient (e.g., Panama Canal or the grid’s transmission network) or when a significant upstream source is taken offline (e.g., LNG terminals or a failed harvest).

How this balance might shift in the final quarter of 2023 is not obvious to me. I can make contending arguments. But in terms of current fitness, I perceive that global supply chains are in healthy shape for the start of the Northern Hemisphere’s winter.