2024 is meant to be the year of the central bank pivot. Central banks seemed to have pencilled in rate cuts for the year- with only the question of timing and extent yet to be determined by data as it rolls in. Base rate effects are helping bring down the inflation rate and price gouging seems to have abated for now in the G7 nations. Measures to moderate demand pressures could also have played a small part in the fall but only marginally so at best. The wild card for inflation this year might, however, be how geopolitical tensions affect commodity and food prices- principal drivers in inflationary indices.
At the centre of global prices for commodities, agricultural produce and even energy is delivery costs. The entire worldwide supply chain which allows the low-cost delivery of goods at an affordable price halfway around the world is critical to world trade. And delivery costs are dependent on delivery routes. And whilst delivery costs are usually a good indicator of global demand (particularly the Baltic freight Index which measures global shipping cost) there is a critical new component to shipping costs which have little to do with overall global demand: regional conflicts.
So, while bond markets have been watching normal economic indicators for clues about the next central bank move- particularly the timing for the first cuts, the current crisis in the middle east is threatening to spiral into a broader regional conflict. And if it does, then all bets are off regarding inflation trends.
The October 7th Hamas attack on Israeli civilians and military personnel has unleashed a reprisal that is bordering on genocidal and surpasses what many consider to be a self-defence action and has crossed the line into a war of extreme aggression. South Africa has brought Israel to the International Court of Justice with a thoroughly documented case arguing that Israel is deliberately targeting civilians, hospitals, all infrastructure including sanitation, water, electricity, schools even, in an attempt to drive the ethnic population out of Gaza by making it uninhabitable. These tantamount to war crimes. The damaging aspect of Israeli actions in the eyes of the world is their brutality which are being actively supported by the United States of America and the UK, also the EU and Australia.
The West is complicit in fomenting instability in the middle east for over a century now; they profit from disunity and weakened states. They have destroyed Iraq, Libya, Syria, and have crippling sanctions imposed on Iran. They back Israel blindly in its flagrant violations of United Nations Resolutions and the US has intervened with its veto a record number of times over many decades to prevent any meaningful action against them.
This is what makes the current situation so volatile. It isn’t Israel against a defenceless Palestinian population but is seen regionally as a proxy war between the US and Iran. Iran is known to back Shia militia throughout the region- from Hezbollah in Lebanon, the Houthi in Yemen, factions in Iraq. The US backs Israel and- without US support, would not have been able to pursue this war for this long. Israel is potentially stirring a hornet’s nest by provoking the Hezbollah in Lebanon- a war that many experts believe Israel is not ready for.
The recent Houthi attacks on shipping in the Red Sea have sent oil prices and shipping cists upwards. The Houthi support the Palestinian fight for freedom from occupation. The Americans bombed Yemen in retaliation against drone attacks on Israeli shipping. And it should not be left out here that Saudi Arabia has been prosecuting its own war against Yemen. The potential for a greater regional conflagration is only one gruesome headline away.
Currently, the Baltic Exchange Dry Index is currently headed lower because the current crisis is still limited in nature- both in location and perceived threat level (the Baltic Index takes a weighted cost of 23 shipping routes for an assortment of commodities) but this could turn around quickly. Already, there are issues elsewhere with drought levels making the Panama Canal a chokepoint instead of a shortcut. If this conflict escalates then we could see shipping costs escalate along with costs of oil. The very real, very recent example of the Russia-Ukraine War impacting prices of oil, nickel, wheat, and other commodities should not be forgotten. Already 95% of shipping exports from India are being re-routed due to these Houthi attacks- doubling the cost of Indian exports. The graph belowshows the spike in 2021 following the invasion of Ukraine.
Fig. 1: Global Shipping Costs
Source: tradingeconomics.com
So, the tinderbox fuse is ready to be lit given the war-hungry players involved. We should also add here the strongly held belief amongst regional experts and watchers that Israel wants the United States to enter into a war with Iran to destroy any nuclear capability it (Iran) might be developing. The danger of an ‘accidental on purpose’ war cannot be ruled out.
And here we have to also add that- because of the El Nîno effect certain crop yields this year may not be as bountiful as needed. Already India has placed temporary bans on rice, tomatoes, and onions, causing global prices to ripple. Australia will report a wheat shortfall most likely- sending up prices there.
What may trip up the world in its return to lower rates (as opposed to low rates) is the return of inflation that cannot be controlled through monetary mechanisms but would still need these mechanisms to be restrictive to prevent a further blowout. That is, inflation arising out of conflicts which cause supply shortfalls do not have a demand solution but will still require central banks to act as if they can control it through tight policies. Other risks also remain in the move towards lower rates- notably the expansionary fiscal policies of the US, a huge debt overhang and cyclical factors pushing up the natural rate of interest but the one which is least anticipated and only reacted to is geopolitical tensions. This time though, it’s almost as if the whole theatre group is waiting in the wings and ready to start the play and people aren’t really watching.