10Y: Inflation Could Creep Back Up as Seaborne Trade Interrupted
CBOT: Micro 10-Year Yield Futures ( 
10Y1!)
Maritime transport is the backbone of international trade and the global economy. Over 80% of the global trade volume in goods is carried by sea, according to the UN. Therefore, whenever a major trade route is blocked, shipping time would be lengthened, which pushes up freight cost, and ultimately, the prices of merchandise.
Suez Canal Blockage, March 2021
Traffic jams at sea are not rare. On March 23rd, 2021, a 400-metre-long container vessel, MV Ever Given, got diagonally stuck inside Egypt’s Suez Canal. Transport was completely blocked in the all-important 193-km narrow waterway for six days.
Suez Canal is one of the world's busiest shipping channels for oil, refined fuels, grain, and other trades linking East to West. It moves about 12% of the global trade. Holding up traffic there could cost $9 billion per day, according to data from Lloyd’s list.
Direct impact: The Baltic Dry Index (BDI), a benchmark for the cost of shipping goods worldwide, traded around 2350 before the blockage. It shot up to 3170 (+35%) by May and peaked at 5530 (+135%) by October. While canal blockage was not the only cause, it exposed weaknesses in global trade and triggered a chain reaction in price hikes.
Influence: In February 2021, US CPI was well under control at a 1.7% annual rate. It jumped to 2.6% in March. By the time BDI peaked, CPI was at 6.2% in October. But it did not stop there, US CPI topped 9.1% in June 2022, 15 months after the blockage.
Panama Canal Drought, August 2023 to Present
The 65-kilometer-long Panama Canal connects the Atlantic and Pacific Oceans and is a key shipping hub for trade between North and South America to Asia and Europe. It links about 5% of global trade. In 2022, more than 14,000 ships passed through the canal.
The Panama Canal is experiencing a severe drought now, resulting in a shortage of fresh water for the operation of the locks. This forced officials to slash the number of vessels they allow through and has created expensive headaches for shipping companies. Before the crisis, 38 ships a day moved through the canal. It’s now down to only 22.
Canal authority now hosts special auctions to allow winner to cut in line and move his ship ahead in the queue. It is reported that shipping companies paid up to $2 million for this privilege, which is on top of the regular canal fees they paid.
Direct impact: Unlike the Suez fiasco, drought would last for months. It’s estimated that daily passage could move up to 24 by January 2024. The canal would still be running at 65% capacity. This means that global trade could be slowed by as much as 2%.
Red Sea Under Houthi Attacks, October 2023 to Present
The Bab el-Mandeb Strait is between the Horn of Africa and the Middle East. It connects the Red Sea to the Gulf of Aden and the Arabian Sea. This waterway is used by container ships and exports of petroleum and natural gas from the Persian Gulf. Approximately 12% of the world’s trade, which includes 30% of all global containers, move through the Suez Canal. That then feeds through the Red Sea and Bab el-Mandeb.
The Yemen-based Houthi militants have threatened to attack any vessels that have ownership ties to Israel or do business there. Overall, 13 vessels have been attacked at Red Sea since the Israel-Hamas conflict broke out in early October.
On Saturday, MSC, the world’s largest shipping carrier, said that its ships will not transit the Suez Canal due to security risks. Shipping giants Hapag-Lloyd and Maersk also paused travel through the Red Sea a day earlier.
Direct impact: The collective vessel market share of MSC, Hapag Lloyd, and Maersk is approximately 40% of global trade. The decrease in vessel transits by these three giant ocean carriers will be a financial hit to Egypt, which owns, operates, and maintains the Suez Canal. Egypt has already seen a hit in tourism due to the conflict.
Impacts from Panama Canal and Red Sea Crisis
The combined trade volume passing through Suez and Panama canals accounts for 17% of global trade. Any interruption, either man-made or by nature force, could reduce global goods supply and add to the price tag on store shelves.
The long wait time at the canal and the extra weeks it takes for using alternative route both increase overall fuel consumption and other expenses. Even though crude oil price has been falling, freight shipping cost are now on the way up. This is like a tax on the economy. The impact on such a global scale could reverse the trend of cooling inflation.
If recent history repeats itself, we could see US CPI creeping back up in the coming months, following a surge in the BDI.
Trading Opportunity with CBOT Micro Yield Futures
Last Wednesday, the Federal Reserve decided to keep the Fed Funds rate unchanged in the 5.25-5.50% range. While Fed officials put out inconsistent statements about what they would do next, investors overwhelmingly concluded that rate cuts are coming soon.
On Thursday, both S&P and Nasdaq made 52-week high, of 4,738.57 and 14,855.62, respectively. The Dow reached a new all-time-high record of 37,347.60 on Friday.
According to CME FedWatch Tool, the first rate-cut could occur in March, with a 69% probability. By the end of 2024, there is a 98% probability that the Fed Funds rate would be 4.25-4.50% or lower, indicating investor expectations of 4-7 cuts of 25 bps each.
(Link: cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html)
In the Treasury spot market, 10-Year yield was quoted 3.928% on Friday. This represents 132 bps below Fed Funds, and a 10Y-2Y spread at -51 bps. In the futures market, CBOT Micro Yield futures (10Y) January 2024 contract (10YF4) was settled at 3.927 last Friday, in line with the spot market.
If our analysis on pending inflation rebound is proven to be correct, the Fed would start cutting rates later than the market expected, and not as much as the Treasury market priced in at the moment.
Each Micro 10Y Yield contract has a notional value of 1,000 index points, or $3,927 at current price. To acquire 1 contract, a trader is required to deposit an initial margin of $320.
If the resurgence of inflation spurred by global supply chain disruption makes the Fed to maintain its hawkish stance and continue tighten the monetary policy, the rates will stay elevated. A trader with a long position will gain if 10Y yield rises.
While a rate hike raises Treasury yield, the postponement of an expected rate cut also has similar effect. The forecasted low yield would now be revised up. As a result, the futures price, which is the 10Y yield, would go up, rendering a profit for the long position.
On the other hand, if 10Y yield continues to fall, the trader would incur a loss of $250 for each 25bps cut.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/
10Y1!)Maritime transport is the backbone of international trade and the global economy. Over 80% of the global trade volume in goods is carried by sea, according to the UN. Therefore, whenever a major trade route is blocked, shipping time would be lengthened, which pushes up freight cost, and ultimately, the prices of merchandise.
Suez Canal Blockage, March 2021
Traffic jams at sea are not rare. On March 23rd, 2021, a 400-metre-long container vessel, MV Ever Given, got diagonally stuck inside Egypt’s Suez Canal. Transport was completely blocked in the all-important 193-km narrow waterway for six days.
Suez Canal is one of the world's busiest shipping channels for oil, refined fuels, grain, and other trades linking East to West. It moves about 12% of the global trade. Holding up traffic there could cost $9 billion per day, according to data from Lloyd’s list.
Direct impact: The Baltic Dry Index (BDI), a benchmark for the cost of shipping goods worldwide, traded around 2350 before the blockage. It shot up to 3170 (+35%) by May and peaked at 5530 (+135%) by October. While canal blockage was not the only cause, it exposed weaknesses in global trade and triggered a chain reaction in price hikes.
Influence: In February 2021, US CPI was well under control at a 1.7% annual rate. It jumped to 2.6% in March. By the time BDI peaked, CPI was at 6.2% in October. But it did not stop there, US CPI topped 9.1% in June 2022, 15 months after the blockage.
Panama Canal Drought, August 2023 to Present
The 65-kilometer-long Panama Canal connects the Atlantic and Pacific Oceans and is a key shipping hub for trade between North and South America to Asia and Europe. It links about 5% of global trade. In 2022, more than 14,000 ships passed through the canal.
The Panama Canal is experiencing a severe drought now, resulting in a shortage of fresh water for the operation of the locks. This forced officials to slash the number of vessels they allow through and has created expensive headaches for shipping companies. Before the crisis, 38 ships a day moved through the canal. It’s now down to only 22.
Canal authority now hosts special auctions to allow winner to cut in line and move his ship ahead in the queue. It is reported that shipping companies paid up to $2 million for this privilege, which is on top of the regular canal fees they paid.
Direct impact: Unlike the Suez fiasco, drought would last for months. It’s estimated that daily passage could move up to 24 by January 2024. The canal would still be running at 65% capacity. This means that global trade could be slowed by as much as 2%.
Red Sea Under Houthi Attacks, October 2023 to Present
The Bab el-Mandeb Strait is between the Horn of Africa and the Middle East. It connects the Red Sea to the Gulf of Aden and the Arabian Sea. This waterway is used by container ships and exports of petroleum and natural gas from the Persian Gulf. Approximately 12% of the world’s trade, which includes 30% of all global containers, move through the Suez Canal. That then feeds through the Red Sea and Bab el-Mandeb.
The Yemen-based Houthi militants have threatened to attack any vessels that have ownership ties to Israel or do business there. Overall, 13 vessels have been attacked at Red Sea since the Israel-Hamas conflict broke out in early October.
On Saturday, MSC, the world’s largest shipping carrier, said that its ships will not transit the Suez Canal due to security risks. Shipping giants Hapag-Lloyd and Maersk also paused travel through the Red Sea a day earlier.
Direct impact: The collective vessel market share of MSC, Hapag Lloyd, and Maersk is approximately 40% of global trade. The decrease in vessel transits by these three giant ocean carriers will be a financial hit to Egypt, which owns, operates, and maintains the Suez Canal. Egypt has already seen a hit in tourism due to the conflict.
Impacts from Panama Canal and Red Sea Crisis
The combined trade volume passing through Suez and Panama canals accounts for 17% of global trade. Any interruption, either man-made or by nature force, could reduce global goods supply and add to the price tag on store shelves.
The long wait time at the canal and the extra weeks it takes for using alternative route both increase overall fuel consumption and other expenses. Even though crude oil price has been falling, freight shipping cost are now on the way up. This is like a tax on the economy. The impact on such a global scale could reverse the trend of cooling inflation.
If recent history repeats itself, we could see US CPI creeping back up in the coming months, following a surge in the BDI.
Trading Opportunity with CBOT Micro Yield Futures
Last Wednesday, the Federal Reserve decided to keep the Fed Funds rate unchanged in the 5.25-5.50% range. While Fed officials put out inconsistent statements about what they would do next, investors overwhelmingly concluded that rate cuts are coming soon.
On Thursday, both S&P and Nasdaq made 52-week high, of 4,738.57 and 14,855.62, respectively. The Dow reached a new all-time-high record of 37,347.60 on Friday.
According to CME FedWatch Tool, the first rate-cut could occur in March, with a 69% probability. By the end of 2024, there is a 98% probability that the Fed Funds rate would be 4.25-4.50% or lower, indicating investor expectations of 4-7 cuts of 25 bps each.
(Link: cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html)
In the Treasury spot market, 10-Year yield was quoted 3.928% on Friday. This represents 132 bps below Fed Funds, and a 10Y-2Y spread at -51 bps. In the futures market, CBOT Micro Yield futures (10Y) January 2024 contract (10YF4) was settled at 3.927 last Friday, in line with the spot market.
If our analysis on pending inflation rebound is proven to be correct, the Fed would start cutting rates later than the market expected, and not as much as the Treasury market priced in at the moment.
Each Micro 10Y Yield contract has a notional value of 1,000 index points, or $3,927 at current price. To acquire 1 contract, a trader is required to deposit an initial margin of $320.
If the resurgence of inflation spurred by global supply chain disruption makes the Fed to maintain its hawkish stance and continue tighten the monetary policy, the rates will stay elevated. A trader with a long position will gain if 10Y yield rises.
While a rate hike raises Treasury yield, the postponement of an expected rate cut also has similar effect. The forecasted low yield would now be revised up. As a result, the futures price, which is the 10Y yield, would go up, rendering a profit for the long position.
On the other hand, if 10Y yield continues to fall, the trader would incur a loss of $250 for each 25bps cut.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/
Jim W. Huang, CFA
jimwenhuang@gmail.com
jimwenhuang@gmail.com
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