If you watch the news or pay any attention to the dollar, you’ve likely already heard the word bandied about once or twice: Inflation. The dreaded word has reared its ugly head, some would say coming back from the dead. Why? Because we have not had to deal with troublesome inflation for decades. But now, with so much money sloshing around the marketplace and businesses raising prices, here it comes. The question is, how bad will it be?
The Road to Today’s Prices
Inflation has nothing to do with your tires. It is invisible. It is not a tangible thing, but you feel it all around you, it represents all the costs in your life, whether it be for food or a car. Inflation also impacts your future. You obviously want to know if you will be able to afford the things you need as prices rise. When businesses raise prices for goods, for whatever reason, that is inflation. Conversely, dropping prices is deflation.
What we are seeing today represents a perfect storm of events, which has precipitated a rise in prices on goods and services. The number one culprit is obviously the COVID-19 pandemic, which forced a dramatic change in consumption patterns. We all remember the toilet paper missing from store shelves. The pandemic created an unanticipated rise in demand for goods to levels not seen in recent history.
Yet, there was no dramatic drop off. We went from no demand for two months when the world went on lockdown, to above average demand and now, as economies open, even higher levels of demand. But disruptions in the supply chain have stymied this rise. With microchips, lumber, and steel facing market shortages, companies are seeing supply chain bottlenecks. As a result, shippers have been forced to get creative on how they get loads delivered, which raised pricing.
Then you’ve got workers sitting on the sidelines because of generous government subsidies and unemployment benefits. This has caused companies to have to increase pay and offer greater benefits to attract workers, which are in short supply. Today, there are just under 10 million job openings, with companies finding it difficult to fill spots. As companies raise wages and add benefits, they may potentially increase prices on their consumers to help pay for it. All these moves cause labor cost inflation.
Just consider commodity prices at this point. The Consumer Price Index (CPI) rose by a higher-than-expected 5% in May. This represents the fastest rise in prices since 2008, according to the Bureau of Labor Statistics. Some are hoping that once the generous unemployment benefits end, workers will come back to work, which will reduce labor cost inflation. Still, the jury is out on whether it will actually play out that way or not. Some think commodity inflation is here to stay.
Not All Inflation is Created Equal
Even as the United States grapples with potentially damaging inflation, the Eurozone inflation gauge has dipped for the first time in nearly nine months. Economists associate this with slower growth in energy and services pricing. Some economists expect inflation to pick back up in the months ahead, but for now the Eurozone is bucking the trend set by the United States.
The Eurozone index of consumer prices in the single currency bloc rose by an annual rate of 1.9% in June, down from a more than two-year high of 2% in May. Meanwhile, core inflation — excluding more volatile energy, food, alcohol, and tobacco prices — fell from 1% to 0.9%. Prices of non-energy industrial goods grew at a faster rate, but this activity was eclipsed by drops in services and energy inflation.
Still, the ECB forecasts that inflation will fall back below its target next year and only reach 1.4% in 2023. Not everyone is on board with this viewpoint, however. Some think the 1.4% reading is a vast underestimation. They look to inflation activity in the U.S. and posit prices will remain high due to a common problem: a weak labor market.
And while unemployment has begun to decline thanks to the Eurozone reopening, there are still a lot of jobless people floating around the Eurozone labor market, at some estimates over 15 million people remain unemployed across the Eurozone. That represents a nearly 2 million jump in unemployment compared to the same time two years ago, before the pandemic.
The Case Against Sustained Inflation
Not all economists – including the Federal Reserve – are predicting a sustained increase in core inflation. You must take a step back and look at business cycles to understand why they have this opinion. The shock to the system during this downturn came from the supply side. Thanks to disrupted global production, supply chains and labor markets could not rise to meet the demand.
Inflation accelerates while industry capacity utilization, employment rates and key commodities levels all remain below pre-COVID levels. It is for these reasons that said economists believe inflation will eventually subside. If it were taking place during the peak of a cyclical expansion, where production factors are at full use, then you would see sustained inflation.
But since there is slack in the labor market, companies should be able to fill positions, especially once the government’s generous unemployment benefits subside. Even if supply disruptions continue to plague the markets, their impacts on inflation will wane as wages rise. Even now, a lot of the early data shows that major supply disruptions are ending.
Waning base effects should push inflation down as car and energy prices begin to fall back down to earthly levels. Fortunately, the Federal Reserve is projecting calm and remains committed to keeping a watchful eye on undesirable inflation pressures. Under its dual mandate, coupled with a new attention to social equity, including ethnic- and gender-based unemployment, the Fed room to affect the market should things get out of hand. And while overall growth and inflation forecasts rose considerably in the latest Federal Open Markets Committee meeting, unemployment expectations stayed steady.
How is Trucking Impacted by Inflation?
The trucking industry was not spared heartache from the effects of the COVID-19 pandemic. Obviously, rising prices does not happen in a vacuum. Companies and entities of all shapes, sizes, stripes, and styles go through the cycle of raising prices to make up for slimmer margins. For trucking companies specifically, expect to see equipment costs continue to rise. To account for the higher raw materials, you might need to add around $7,500 to a trailer that might already come in at $30,000.
Look at the data and you can see a recent drop-off in equipment orders. We can assure you; it has nothing to do with OEMs being out of supply. In fact, it is because they are being forced to 1) reprice their current backlog of inventory and 2) fleets are unable to afford the higher prices.
Fleets will also face headwinds on the operational side. Truck driver costs will only continue to rise, with current increases already approaching 10% higher year-over-year across the industry. Staffing costs, higher wages, and skilled worker shortages will add another 3% to 4% increase through the second half of 2021. Even fuel costs are registering the pinch, having risen 34% year-over-year. Expect to see fuel costs also rise by another 3 to 4% before the clock rings on 2022.
As we discussed before, spot rates are also skyrocketing, a full 60% higher than the same period last year. This implies that higher purchase costs could be here to stay at least through the medium term. Many motor carriers are simply absorbing about 40% to 50% of this higher cost but will still pass some of it on to the end consumer. Expect to see another rise of around 1% to 2% to account for higher prices in the spot rate market.
Add all these numbers together and what do you get? An estimated 10% to 12% rate increase across the board, no matter the segment (though LTL will see a bit of a lesser impact). At this time, the market is allowing fleets to recover those costs, which has resulted in rising margins for many trucking companies, no matter the size.
Still, the definition of inflation points to sustained increases. How long will trucking companies be able to continue to price at these elevated levels? Perhaps one more year? Even so, all the costs associated with driver acquisition, retention, equipment, insurance, travel, and food will all have a big impact over time. Industry analysts are expecting them to continue through 2022, further crimping fleet managers’ budgetary purchasing power.