How do supply chain disruptions contribute to inflation?

Supply chain issues were major contributors to the early 2020s inflation spiral that, by June 2022, drove inflation to highs not seen in decades. Manufacturing delays and shipping bottlenecks combined to result in product shortages. With demand outstripping supply, prices soared. But over the past two years, the situation has steadily improved. Most segments of the economy are experiencing only limited supply chain disruptions today, which is helping relieve inflationary pressures.

Some problems remain. One of the biggest concerns dating back to late 2023 is that many shippers have diverted traffic from the Red Sea. This critical Middle East waterway is the scene of frequent Yemeni-based Houthi militant cargo vessel attacks. It’s caused many shippers to avoid this critical waterway, extending shipping times and adding expense. However, U.S. inflation continues to decline despite the delays caused by many shippers avoiding Red Sea routes in favor of longer and costlier alternatives.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. “But we aren’t seeing sustained issues with commodity prices.” While oil prices rose to the mid-$80-per-barrel range in early 2024, prices have since retreated.

Falling energy prices 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 2.9% for the 12-months ending in July 2024, as measured by the Consumer Price Index.²

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

Global supply chain issues evolve

Potential global 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. That 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 of raising the federal funds target interest rate it controls more than 5% from 2022 to 2023.

Ongoing semiconductor chip concerns

The demand is growing for semiconductor chips. In a previous era, chips were mostly associated with electronics, primarily computers. Over time, products ranging from refrigerators to automobiles are dependent on semiconductor chips. Dating back to late 2020, a backlog of chip orders led to a shortage of many products, most notably 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 flattening consumer demand for goods. As a result, price pressures eased. “Over the past couple of years, consumers spent more on experiences and spent less on goods,” says Haworth. “If the environment changes, and consumer demand for cars and other durable goods soars, it could put more pressure on the market, but that’s not the situation today.”

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 persist to insufficient numbers of workers to fill available American jobs. Based on recent jobs data, more than one position is open for every available worker, demonstrating a need for more workers to fill available jobs.² “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.

The International Longshoreman’s Association is currently in negotiations on a new contract. Any delays that result in work stoppages might create new issues, but talks are still ongoing.

Where we go from here

The clearest sign that supply chain issues are under control for now is inflation’s continued decline. “We’re not at the same point we were during the peak of supply chain issues a few 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 started slower in 2024’s first quarter, with the economy expanding at an annualized rate of 1.4%. The pace picked up in the second quarter, to an annualized growth rate of 2.8%.³ 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.