Macro Strategy
Permeating Risk Landscape
- Rising geopolitical tensions give rise to two primary risks: Supply Disruption & Inflationary – which could impede the disinflation trend.
- The latest Beige Book reports further points for a soft-landing scenario and indicates a setting for more gradual rate cuts.
- BI continues to prioritize IDR stability, with a rising OMO trend and higher inflows into BI’s SRBI instrument.
Geopolitical Risk is Escalating. Heightened tensions in the Red Sea have led to a redirection of shipping routes between Asia and Europe. The Red Sea route accounts for nearly 12-15% of global seaborne trade traffic. In our view, the primary concerns are twofold:
- Supply Disruption Risk: Traditionally, container vessels traveling from Asia to Europe pass through the Red Sea before reaching the Suez Canal - a vital passage accounting for 12-15% of global trade, supporting 12% of seaborne oil, and facilitating 8% of LNG transits. However, due to heightened risks in the Red Sea, vessels are now compelled to take the longer route around the Cape of Good Hope, thereby extending the standard 26-day journey between Singapore and Rotterdam by an additional 10 days.
- Inflationary Risk: Besides the extended travel time, this alternative route results in an extra USD 1 million in shipping costs for each round trip. War risk insurance has surged from 0.07% in early December to 0.5%-0.7% of a ship's value in mid-December. Consequently, the number of ships transiting the Red Sea and Suez Canal has witnessed a 39% decline in early January compared to the same period last year. While the impact on inflation remains relatively muted for now, the escalating shipping costs, while at faster paced than during the pandemic, are translating into inflation at a slower rate. The timing of annual freight contract negotiations around March-April, as per Freightos, might allow for tensions to subside.
While the market still seems to factor in the expectation of a more contained crisis, the current geopolitical risk continues to hinder global progress towards disinflation. This, in turn, could affect the timing and magnitude of rate cuts this year.
Soft-landing Scenario Would Lead to More Gradual Rate Cuts. Towards the end of 2023, the US economy still exhibited notable economic resilience, as emphasized in the latest Fed Beige Book, with the key points as follows: 1. Seasonal demand played a crucial role in elevating economic activity, particularly within the services sector. Expectations for future growth were generally positive or showed an improvement; 2. Signs of a protraction of a cooling labor market with easing wage pressures; and 3. Price increases are expected to persist although at a more subdued pace compared to the post-pandemic period.
Federal Reserve Atlanta GDPNow forecasts 2.4% q-q growth in 4Q23, much stronger than the consensus figure of 1.8%, yet notably lower than the 5.2% seen in 3Q. This deceleration may signify a soft-landing scenario, which corroborates our monitoring of comments made by Fed members, which leaned toward hawkishness leading up to the Jan FOMC meeting. The divergence in the timing and magnitude of rate cuts remains large, with the market anticipating a rate cut as soon as March, with 150 bps of rate cuts this year, or double the Fed’s latest dot plot readings.
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