Red Sea crisis not a threat to US economic outlook

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The US economy appears to be heading towards a soft landing, but recent attacks by Yemen’s Houthis in the Red Sea have prompted fears that disruption to global trade and energy markets could derail much of the progress the country has made in its inflation fight.

Significant gains have been made in bringing inflation back down to the Federal Reserve‘s long-term goal of 2 per cent. Inflation has climbed down from the 7.0 per cent recorded in July 2022 to its current level of 2.6 per cent.

But geopolitical risks are contributing to the uncertainty the Fed faces in taming inflation. And recent attacks on commercial vessels by the Iran-backed Houthis in the Red Sea have prompted the UN to sound the alarm that disruptions to trade and energy could reignite inflation.

So far, however, the US economy appears well positioned to be mostly unaffected by the Red Sea crisis.

Global trade disruptions

Roughly 11 per cent of global maritime trade volume passes through the Red Sea, according to the International Monetary Fund’s Port Watch tracker.

Houthi attacks in the region have led to companies rerouting vessels around Africa’s Cape of Good Hope. The additional time in transit – roughly two weeks – has prompted concerns of increased shipping and energy costs.

The extended transit time has resulted in higher insurance rates and shipping costs, but not at the rate necessary to derail the US economic outlook.

“I don’t think that’s going to be what blows up the 2 per cent inflation target,” Joseph Francois, managing director and economics professor at the World Trade Institute, told The National.

“If it goes to hell in a handbasket, all kinds of things happen. But then it’s disruptive for other reasons, too.”

Mr Francois noted that Europe, whose economy is more dependent on transit through the Red Sea via the Suez Canal, is more vulnerable to disruptions.

European Central Bank President Christine Lagarde also acknowledged the risk of heightened tension in Europe’s own quest to tame inflation.

While incidents in the Red Sea mostly affect European, Mena and Asian economies, Mr Francois said the US must look to the Panama Canal.

“In the US, most traffic is disrupted by the Panama issue and not by the Middle East,” he said.

The Panama Canal, a major water way in which 40 per cent of US container vessels ship through, has seen shipping volume drop by 36 per cent because of drought.

Shipping volume in the Suez Canal, affected by geopolitical tensions, is down roughly 30 per cent.

“Together, it’s a bigger disruption than either one by itself,” Mr Francois said.

And while retailers are bracing for potential bottlenecks, they are unlikely to have the same consequence as the supply-chain squeeze caused by the Covid-19 pandemic.

Mr Francois said companies have adjusted their behaviour towards trade disruptions since the pandemic.

“As long as you get disruptions that just delay things for a while or temporary, firms are ready. They decided that this is the world we live in now,” he said.

Energy markets and US oil production

Bab Al Mandeb is a critical route for trade and oil transport between the Arabian Gulf and Asia, as well as Europe via the Suez Canal.

Roughly 10 per cent of the global seaborne oil trade and 8 per cent of liquefied natural gas trade passed through the Suez Canal last year, according to the International Energy Agency.

So far, though, energy markets have been little moved.

Steven Fries, non-resident senior fellow at the Peterson Institute for Economics, said the alternate transit route is “not disrupting supplies in a significant way”.

“They’re simply longer in transit and the oil market will adjust over time to the additional shipping time and costs,” he told The National.

As of Thursday, Brent Crude, considered the global benchmark for oil, was trading at $82.32 per barrel. West Texas Intermediate – the benchmark used in the US – was trading at $77.36 per barrel.

In the event of a shock, Mr Fries expects oil-reliant Europe to be more affected than the US.

“Even if there is a large energy price shock, European economies tend to do less well than the North American economies because they’re don’t produce much domestic oil and gas and they’re heavily reliant on imports,” said Mr Fries.

And increased production in North America means that growth in demand “can comfortably be supplied”.

Much of that oil production has been done in the previous two years, spurred on by Russia’s invasion of Ukraine and voluntary Opec cuts in production.

The US is producing 13.3 billion barrels of crude oil per day, according to S&P Global. It is so strong, in fact, that it is exporting near the level of production in Saudi Arabia and Russia.

The ramped-up levels in US oil production have played a significant role in lowering fuel prices. At $3.08 per gallon on average, people are spending less on petrol today than a year ago ($3.42/gallon).

“Prices are not so bad. So I don’t see much pressure there” for the moment, Mr Francois said.

The big ‘If’

Much of the conversation surrounding the US economic outlook on the Red Sea crisis has been largely positive, with the giant asterisk that it could quickly unravel should the crisis seriously escalate.

“I don’t see it potentially being a big, big impact on … US inflation,” Federal Reserve Governor Christopher Waller said.

That is, unless, “this thing spirals into something much more severe than it appears that it is right now”, he said.

And since National Security Council spokesman John Kirby told reporters on January 3 that the crisis “can have an effect on the global economy”, the US has led at least nine rounds of strikes against Houthi targets in Yemen, upping the threat of escalation.

A great deal of uncertainty remains, both in terms of length and escalation of the crisis.

President Joe Biden acknowledged the US-led attacks have done little to deter the Houthis, but vowed that military action would continue.

It is that very uncertainty that puts the US economy in a precarious position despite its strength.

Should the crisis in the Red Sea considerably escalate, the US economic outlook will be tested.

Updated: January 29, 2024, 3:56 AM