How do supply chain disruptions contribute to inflation?

Shipping has had the greatest impact on the global supply chain in the past year. Much of it centers on Yemeni-based Houthi militants disrupting key Middle East shipping routes in the Red Sea with frequent attacks on cargo vessels. As a result, many shippers have chosen to avoid this critical waterway, extending shipping times and adding expense. There are concerns that this and other factors could drive shipping rates significantly higher, which may have inflation implications.¹ In the meantime, the U.S., Britain, and other nations are using military resources to try to protect shipping lanes in the Red Sea, so far with mixed results.

“The Red Sea is important for moving oil, particularly to Europe,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “It’s possible the disruptions caused by the Red Sea threats to shipping contributed to a recent upswing in oil prices.” Oil prices trended higher and stayed elevated through much of 2024.

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 3.3% for the 12-months ending in May 2024, as measured by the Consumer Price Index.² However, inflation has lingered above 3% since mid-2023, and the recent oil price rise has likely played a role.

“There’s the potential that shippers resorting to longer routes to avoid the Red Sea may start to impact the availability of ships, because transit times have been extended to divert to other routes,” says Haworth.

What’s the risk that supply chain issues could again contribute to inflation’s resurgence?

Evolving supply chain concerns

Potential supply chain issues in 2024 differ from what initially sparked inflationary concerns in 2021. After the onset of the COVID-19 pandemic, 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.

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 reduced supply chain stress. “Durable good sales are also affected due to higher costs of borrowing to purchase big ticket items like automobiles,” notes Haworth. Tempering demand to cool inflation was part of the Federal Reserve’s strategy in eleven hikes of the federal funds target interest rate it controls from 2022 to 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.³ That helped ease price pressures.

The new CHIPS and Science Act incentivizes construction of domestic semiconductor manufacturing plants. It includes a federal government financial commitment to support the development of the domestic semiconductor industry. “This represents a deeper investment in U.S. chip manufacturing infrastructure,” 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 1.2 positions are open for every available worker, demonstrating a need for more workers to fill available jobs.⁴ “The number of job openings is slowly creeping down and the gap of workers to fill available jobs is closing, but an imbalance remains,” says Haworth.

“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

While events like the Red Sea attacks on private shippers add to specific supply chain concerns, there’s no clear impact on the broader inflation rate. “We’re not at the same point we were during the peak of supply chain issues several years ago,” says Haworth, “but there are some risks.” Haworth notes that while goods demand is relatively flat, “We also aren’t seeing a stockpiling of inventories of goods, so if demand suddenly picked up, a production ramp-up might be required.”

Despite higher interest rates, the U.S. economy demonstrated resilience in 2023, avoiding a recession. The economy grew by an annualized rate of 2.5% in 2023, an unexpected improvement on 2022’s growth rate of 1.9%. Growth slowed a bit, to an annualized rate of 1.3% in 2024’s first quarter.⁵ Persistent consumer demand and a strong job market continue to influence economic growth. Investors will closely 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.