On the Radar

City National Rochdale, | Oct. 28, 2021

FAQs on the Markets and Economy

The news has a lot of articles on stagflation; is that a risk to the economy?

We do not see stagflation as a risk to the economy. It tends to be a problem during recessions, and we do not anticipate one for the foreseeable future.

The term “stagflation” (meaning a state of the economy in which stagnant economic growth is accompanied by high inflation) seemed to have left the lexicon a few decades back, when it last occurred in the U.S.

To represent the discomfort of stagflation, famed economist Arthur Okun developed the Misery Index, which is calculated by adding the unemployment rate to the yearly change in the consumer price index (CPI). Although the Misery Index is currently slightly above the long-term average, it is nowhere near the levels of the 1970s and 1980s, when both components were in the double digits.

We expect the unemployment rate (4.8%) to continue to fall as businesses are eager to hire workers; it was 3.5% before the recession started. In addition, the inflation rate, although elevated, is expected to fall in Q2 as the supply/demand imbalance begins to correct itself.

Recent concerns over rising energy costs are understandable. Higher energy prices act as a tax on consumers and have the potential to reduce consumption and overall economic growth. But understanding why the prices of oil and other energies have risen recently gives us important clues about how the economy and markets may evolve from here.

High demand for energy is currently benefiting from the reopening of the economy and gradual return to normal. At the same time, the ongoing pandemic and restrictions that are still in place in many parts of the world have shifted consumption patterns toward goods and away from services, which translates into higher energy consumption for manufacturing-focused economies.

On the supply side, output limits from OPEC, supply chain bottlenecks, the transition away from fossil fuels toward low-carbon alternatives, extreme weather events and geopolitical developments have all worked to retrain constrained production over the past several months.

As a result, global crude inventories that ballooned during the lockdown phase of the pandemic have now shrunk to the lowest level since January 2020. The good news is that there is plenty of scope for energy producers to increase production in coming quarters to offset supply shortages, if they persist. However, the shock brought about by the pandemic to economic activity around the world has been enormous, and it will likely take time before supply and demand imbalances are eventually brought back into equilibrium.

In the meanwhile, we think that consumers can withstand any temporary inflationary pressures from higher energy prices and that the impact on the economy will be manageable. Household finances are in good shape, with the personal savings rate elevated and wages rising at the fastest rate in more than a decade.

It’s also important to remember that the U.S. economy is far less reliant on oil today due to significant energy efficiency gains over the years. Total energy consumption as a percentage of GDP has fallen by more than half since the 1970s, when frequent energy shocks caused stagflation.

Cargo volume at U.S. ports has recovered nicely since its pullback during Q2 2020, with consumer goods demand driving throughput to levels not seen in at least six years. The disruptions in the global supply chain over the past 12 to 18 months are likely to persist into 2022, with continued vessel bottlenecks at U.S. ports. Further compounding the challenges are labor shortages (e.g., transport) and distribution and logistics issues. While capacity constraints at U.S. ports are likely to create operational risks over the near term, we do not expect a material impact on their credit quality.

Surging cargo volume is ordinarily not a bad problem for a port. But ocean carriers that turn away or avoid congested ports can create a different problem that might lead to the loss of business (i.e., volume) and, thus, loss of revenues. Vessels are waiting days or perhaps weeks to unload their cargo. The Port of Los Angeles recently reported its average anchorage-to-berth wait time hit a record 13 days in October 2021. Average “dwell time,” or the time it takes to handle containers on the dock, continues to rise, reflecting the inability to move cargo quickly. The slower turnaround is leading some U.S. ports to extend their hours of operation, in some cases to a 24/7 schedule, like the San Pedro Bay Port Complex in California. However, ports have exhibited resiliency during past disruptions, and as they work diligently to alleviate some of the congestion pressure, we expect them to manage these concerns.

Most U.S. ports benefit from revenue profiles that somewhat insulate their cash flow from short-term volume risk (a landlord model), with tenants paying fixed minimum amounts for leasing terminals and other assets. Conversely, operator ports rely on customer usage, exposing their revenues to fluctuations in container volume, but are nevertheless reasonably positioned. Entities in the port sector, particularly the largest enterprises, typically generate healthy levels of debt service coverage and hold strong levels of liquidity on their balance sheets, providing ample flexibility to navigate a range of outcomes. We continue to monitor all developments associated with the supply chain, the shipping industry, and macroeconomic effects on U.S. port operations.

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Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources, and although believed to be reliable, it has not been independently verified, and its accuracy or completeness cannot be guaranteed.

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