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Will Increased Freight Costs Drive Inflation?

Some are beginning to openly wonder: Will soaring truck costs drive an increase in inflation? Consider the fundamentals behind this argument. We are currently operating in one of the tightest trucking markets in recent history. The overall increase in freight demand has been stoked by an expanding U.S. economy. The sharp increase in freight costs are spurring companies who live and die by the supply chain to pass those higher delivery costs on to consumers.

Compounding the problem is a shortage of available truck drivers, a nebulous regulatory landscape, and ever-increasing demand. Higher materials prices, partly a result of the tariffs put in place by the Trump administration, are also putting more pressure on goods producers, shippers, receivers, and consumers. With demand exceeding capacity in a major way, pricing power has erupted to levels high enough that economists across the board are starting to voice broader concerns about the economy.

A Deeper Look at the Data

But what does the data say? Looking at producer-price figures released by the Labor Department showed that inflationary pressures continued to advance throughout June and July. In fact, general long-distance freight trucking costs rose 9.4% in June compared to the same time a year earlier. Consider this: That jump represented the largest year-over-year increase in long-haul freight costs in almost ten years. And how did that jump translate into the normal economy? The broader producer-price index jumped 3.4% the highest increase in that measure since the final quarter of 2011.

Digging deeper into the financial metrics, it isn’t hard to find anecdotes signaling higher costs impacting the market. In the Federal Reserve’s latest Beige Book report, one trucking company based in North Carolina reported customers paying shipping rates that were roughly quadruple the same rates mere months before. There is plenty of evidence showing that long-haul freight costs are dramatically increasing.

The Cass Index measure of per-mile rates (minus fuel charges), jumped 9% in May, which represented the largest spike in per-mile rates in at least 13 years. Even more, per-mile rates for dry vans, reefers, and flatbeds have increased to over $2 per-mile. Tighter capacity, fueled by the implementation of the electronic logging device mandate and shortage of truck drivers, could see rates rise by another double-digit margin, with utilization remaining solidly around 100% for the year.

With the U.S. economy on a tear, business investment and consumer spending continue to accelerate. All this movement puts a big strain on the already-overburdened freight sector. And while the ELD mandate is a good thing in that truck drivers can no longer work outside the system, truck drivers are now held to far more stringent rules, which presets another unwanted capacity constraint.

Large companies like PepsiCo Inc. are doing their best to mitigate higher transportation costs, but the increase continues to put pressure on their margins. With freight costs accelerating due to the truck driver shortage and trucking regulations, demand is going through the roof, which further drives prices and strains pricing controls.

Another prominent marker of the problems facing the industry lies in big-rig demand. The demand for available trucks firmed up in early 2017 and continued to gain steam throughout the year. May shipment data was the strongest is has been since the Great Recession and nearly broke a record set back in 1990. With records being broken on such a widespread scale, it isn’t difficult to see why transportation costs are reaching all-time highs.

It is important to also look at historical data. In December 2017, shipments were up 7.2% over the year prior. Generally, the shipments index drops sharply with the end of the December shipping season, but in 2017, it dropped by a marginal amount. With nearly $25 billion in transactions supporting this reading, even a small drop represents a big change from previous years.

While government figures show that motor carriers are increasing their payrolls, the level of increase is lower and slower than the pay recovery seen after the last two economic expansions. The evidence of this can be seen in the details.

In 2017, wage gains merely matched the rate of inflation, rather than outpace it. Looking at past data, approximately 30 percent of rate increases trucking companies implement are driven back into wages. The fact is, truck driver pay has been modest for much of the economic expansion underway in the U.S., though the tight market and surge in rates could change that.

Trucking as Leading Market Indicator

Over the past 10 years, inflation has remained largely in check. Both economists and politicians have been looking for economic signs that inflation has been picking up, but even with increased gains in GDP and low unemployment, the overall reading has remained low. It looks like that paradigm is about to change, however.

In fact, there are now multiple signs that inflation may be starting to rise. Freight-related industry inflation sits at historical highs. Ugly price pressures could be building across the economy, which could have major consequences. Recent DAT readings have showed the demand for vehicles is climbing ever-higher. With the employment squeeze resulting in less available truck drivers, capacity problems are putting pressure on freight brokers.

Loads on the spot market are also up over 100% from the same period in 2017. Another measure of inflationary pressures can be seen in the flatbed load-to-truck comparison. This reading tracks the number of vendors looking for flatbeds, which is generally the most in-demand of all trucking types. This measure is up a whopping 142% over the same time last year and over 200% over the year prior.

Beyond the flatbed demand rate, every other broad market measured showed year-over-year double-digit growth. Even fuel costs are up 20%. The transportation sector represents a leading indicator of overall economic growth and activity. Spot market rates for flatbeds were at $2.71 per mile for the week that ended on May 12. That represented a mere penny off their previous record.

In fact, a number of transportation companies reported big jumps in the first quarter of 2018. With rates and fuel prices rising in a big way, market dangers abound. With the spot market pressures not letting up, could higher inflation be just around the corner?

Measuring Inflation Risk

It is important to remember that the numbers by themselves do not indicate that inflation is about to skyrocket anytime soon. While the most recent readings of the consumer and pricing indexes do show potential inflationary pressures rising, the increases seem to be pretty benign.

Indeed, the New York Fed’s Underlying Inflation Gauge rose 3.2% in April, which tracked a similar path as the producer price index. Another reading, which came from the Atlanta Fed’s Sticky-Price CPI gauge, which tracks goods that are less prone to market fluctuations, rose 2.5% in April, which topped the previous high for the reading in February.

While we talk about the Fed, it is important to note that they are continuing to raise interest rates, with the expectation that there will be at least two more quarter-point hikes later this year. Central bank officials have been paying close attention to the leading economic indicators and if we see inflation signals increasing, we could see a faster pace of rate increases down the road. While it is inevitable that prices will rise, many expect the Fed to take greater action should inflation pick up steam.

When price pressures are above and beyond the normal reading, the extra costs must go somewhere. With truck drivers and motor carriers charging more for their services, the buyers of the freight delivered on those trucks are going to pass those costs down to consumers.

Although the producer price index rose moderately over the past 12 months, the freight sub-indexes have reported something entirely different. The truck transportation index rose 6%, the rail index rose 5.1%, and the air index rose 3.9%. The overall freight index, when aggregated across intermodal sits just below the all-time high it hit in February. With intermodal demand outstripping supply, inflationary pressures are rising across the economy. There is a fundamental rule in the marketplace: higher volumes lead to greater pricing pressures. Volume will rise before pricing improves and conversely volume drops when pricing weakens.

What does this all mean for the future of consumer prices and overall inflation? It is important to note that the transmission of higher freight costs to the U.S. consumer does not happen overnight. Still, these higher prices will be working their way into the overall economy over time.

With the economy continuing to improve and consumer sentiment rising, only time will tell what the future holds for U.S. monetary policy. As nerves get rattled and many wonder what the future holds for broader pricing measures, transportation industry advocates and companies will be paying close attention to moves, whether small or large.

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