Chemical prices start to slide in Asia and Europe, as summer slowdown starts early

Chemicals are the best leading indicator for the global economy. They are giving a surprisingly downbeat message for both Europe and NE Asia. As the ICIS chart shows:

“Pricing for commodities across both regions during Q2 is on a downturn, as demand remains subdued.”

Q1 SAW ‘APPARENT DEMAND’ INCREASE AS OIL PRICES ROSE

Normally, the first half of the year is seasonally very strong:

  • Companies destock before Christmas and then need to restock in Q1 after the holidays
  • They also need to build inventory ahead of peak demand as better weather arrives
  • Construction and auto sales normally take off as winter ends
  • Asian demand also rises after Lunar New Year and factories restart
  • But this year, it seems these seasonal influences are unusually weak.

As the chart of ICIS Pricing Indices shows,  they showed some recovery in Q1. But this seems mainly due to freight and oil price influences:

  • The Houthi attacks caused European imports to be delayed by Red Sea disruption
  • They added to the problems created by Panama Canal disruption, discussed in January
  • Buyers then began to buy forward as oil prices began to rise
  • They know that chemical prices always follow oil price levels

Q1 therefore seemed to show a reasonably strong picture.

The problem is that this reflected ‘apparent demand’. Oil prices had risen due to OPEC quotas. And buyers bought ahead because they thought end-user demand would rise.

ICIS price indices are telling us that ‘real demand’ hasn’t really risen. The Global Index is still 22% below its 2022 peak. NE Asian prices are down 19%, NW Europe is down 24% and the US Gulf is down 31%.

CHINA’S DEFLATION CONTRASTS WITH WEST’S INFLATION

What happens next is therefore an important question.

One key issue is that China’s Producer Price Index (PPI) is very weak. As the chart shows, it (and China’s CPI), have been weak/negative since Q3 last year. But Western CPI is still above central banks 2% target level:

  • China is seeing a major slowdown as we discussed last week as the property bubble bursts
  • It needs to restructure to boost domestic consumption. as Peking University’s Prof Michael Pettis notes
  • It is only 37% of the economy today, nearly half US levels, as we discussed last month
  • But instead China is trying to boost exports to create jobs – and risking a major trade war

At the moment, therefore, China’s economy has decoupled from the West.

WESTERN INFLATION IS CURRENTLY DUE TO SERVICES, NOT GOODS

. As the Bloomberg chart shows for the US economy:

“Two years ago there were major shocks to the prices of goods, food and energy, all of which have now dissipated. That’s why inflation is much lower now. The problem is that services inflation remains stubbornly high, and accounts for substantially all of headline inflation at this point. Services are people-heavy businesses in which wages are crucial drivers of prices.”

Western economies are therefore in a different position from China, where wages are kept low as a matter of policy to keep exports competitive.

It seems likely that the Fed’s move to raise interest rates from 0% – 5.33% will now cause wage inflation to reduce, by raising unemployment.

Rate moves normally take 12-18 months to work through the economy, so the cumulative impact of the rises is only now starting to appear.

WARS ARE ALWAYS INFLATIONARY AS THEY DIVERT RESOURCES TO THE MILITARY

There is, of course, another issue driving inflation in the West, as the chart highlights. Europe/USA are effectively at war with Russia and her allies in Ukraine.

Effectively, we have gone back to the Cold War period, before the fall of the Berlin Wall in 1989. Defense spending peaked at ~8% of GDP, but then fell to ~2%.

Today, it is going back to higher levels again. And this is inevitably inflationary, as health and other social spending starts to be squeezed:

  • ‘Business as Usual’ today is effectively “continuous instability”. Military flashpoints are developing, and defence spend is ramping up
  • We are seeing ‘Growing Disruption’ as trade barriers increase around the world – and countries escalate defence spend
  • The next stage seems likely to involve ‘All-out Trade War’, where trading blocs form. And Cold War 2.0 leads to military alliances and major increases in defence spend

Companies and investors now have to refocus on the broader landscape again. The fall of the Berlin Wall meant companies and investors no longer needed to worry so much about developments in the wider landscape.

But now geopolitics are starting to fragment the global economy again. Economics are no longer the key driver for decisions. And so we need to focus on the geopolitical risks ahead.