Global trade what’s going on right now?
As we enter the last few weeks of 2015 our thoughts naturally turn to the New Year and the prospects for 2016, the data that we will see and the trading opportunities that may present themselves as a result.
We touched on those themes in our recent articles about Monetary Policy Divergence and the Future Path of US interest rates.
However some odd and rather concerning things are happening right now, that may have a bearing on events next year or at that very least provide some clues as to what we can expect then.
Trade and Forex
The Foreign Exchange market effectively grew out of global commerce. As merchants and suppliers traded with each other across borders and overseas, they needed a reliable and fungible method of payment. The Lydian civilisation, in what is now modern day Turkey, created the first such method of payment and transfer via the use of standardised & certified gold coins, around 700 BC.
The Lydians grew extremely rich very rich, in fact quite literally as rich as Croesus. Since those ancient times trade and the exchange of money have been inextricably linked. And though the modern Forex market has taken on an identity of its own, beyond facilitating trade, it still pays "lip service" to the movement of goods and services around the world.
Cause for concern
With the above in mind it is somewhat disconcerting to look at what has been happening in recent weeks to the cost of moving goods around the planet. Trade is globalised now and whilst services and intellectual property can move round the globe freely in every sense. Physical goods must be transported from their point of origin to their final destination and naturally there is a cost for that transportation.
That cost is reflected in the rates charged by the international shipping markets, be it for dry goods, containers and their contents or TEUs as they are known, or liquids, which are principally Oil and Gas and their derivative products.
A dry index
Freight rates are the charges levied by carriers and ship owners to move goods around the world. There are many methods of tracking changes in these freight rates. Perhaps one of the best known of these is the Baltic Dry Index, named after London's Baltic Exchange, the home of shipping. The index tracks charges levied along 23 shipping routes, for vessel sizes which range from the Handysize of less than 50,000 tonnes deadweight to the largest Capesize vessels, which can reach as much as 400,000 tonnes deadweight.
The Baltic Dray Index has been under pressure since the credit crunch and the great recession which followed. But in the last week the index has broken down to new record lows as the supply of available vessels outweighs the demand for their use.
The Baltic Dry Index five year chart (source Bloomberg.com)
The index has bounced from the low of 498 posted on the 21st of November but the fact that it could move there in the first place is of concern. Though not entirely unexpected, when you consider that the index has fallen from its peak of 11793, seen in May 2008. The Baltic Dry Index is weighted towards the transportation of industrial goods such as Coal and Steel, both of which have experienced falling global demand alongside chronic over supply. Factors that as the UK economy knows only too well can decimate an industry.
The global goody box
It's not just the lack of demand for the transport of industrial commodities that gives pause for thought however because there have been wild gyrations in the prices charged for the movement of Containers and their contents or Twenty Foot Equivalent Units (TEUs). These ubiquitous boxes facilitate the transport of the vast majority of the things we consume and desire in todays globalised economies. So the fact that since late October TEU rates, on key Asia to northern Europe routes, have fallen by 70% is enough to make one sit up and pay attention.
The sharp fall in the cost of moving TEUs from Asia to Europe has also created a sharp divergence between current rates and their long-term average as we can see from the chart below drawn by the ever topical and outspoken Zero Hedge blog.
Containerised Freight Rates in 2015 & 2008 compared to the thirty year average rate
Source: Zero Hedge
The charts above compare the current deviation from the long term average of containerised freight rates alongside that seen back in 2008, when the world was in the teeth of the credit crunch. Whether or not this is a portent of further tough times ahead is point of discussion. Not least because the world is a much different place today than it was in 2008. Although I have argued elsewhere that there are similarities, in as much as central bank QE has replaced the excessive credit creation that led to the 2008 collapse.
Route Causes
What factors might be behind the dramatic slump in freight rates? As we know only too well modern markets have developed directional liquidity, meaning that liquidity persists when a market is trending nicely but quickly disappears on any significant reversal or dislocation, causing sharp price movements
Markets are, as we discussed last week, forward looking and try to price in expectations of what's ahead rather than what has already occurred.
China released Balance of Trade data back on the 8th of November which showed a drop in exports of 6.9% alongside a fall in the volume of imports of a whopping 16%.
Now let's look at the chart below which plots Chinese GDP growth against Chinese Imports.
We can see that the two lines are closely correlated and that on several occasions in the recent past The Import data has acted as a leading indicator, or led the way if you prefer, for GDP on the downside. Given that few people if any believe China's headline growth numbers, you can easily see why freight rates dropped so dramatically.
Chart plots China GDP Growth vs China Imports (Source Trading economics)
There is no need to panic just yet, but I for one will keeping a closer eye on what's happening to global trade and shipping rates from now on.
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