[Excerpt from The Pickett Line July 2021 Issue]
If the first 25 days of July are representative of the Q3 ahead of us, we are back on track – at least from a US TL Rate Cycle standpoint. After suffering the most extreme inflationary kink observed last quarter in fifteen years of tracking the US Truckload market, initial Q3 pricing signals point to a return to expected cycle trajectory in the months ahead. That said, so long as the spot market runs Y/Y inflationary, which it likely will continue to do through the end of the quarter, it remains vulnerable to disruptive shocks from things like major hurricanes along the gulf coast or a sudden spike in diesel prices. As we painfully observed earlier this year with Winter Storm Uri, a shock of sufficient magnitude, duration, and scope could tug the cycle trajectory from its otherwise normal path and kink our chart temporarily until the dislocation is resolved – though typically not by more than a quarter based on past history. And while none of these market shocks is ever considered to be particularly likely, if the last year has taught us anything, it is to expect the unexpected.
But before we dive into the Q3 outlook, let’s take a moment to summarize the wild Q2 that is finally behind us. For context as we look back at the cycle behavior leading into the quarter, we notched what we believed to have represented this current cycle’s inflationary peak way back in Q4 2020 at +40.2% Y/Y – itself a record high at the time – which was then confirmed by Q1 2021’s lower Y/Y close of +38.9%. However, rather than continue the expected deflationary descent lower the following quarter, the spot market reversed course and surged all of the way up to a Q2 close of +56.1% Y/Y – driven by March’s catastrophic Winter Storm Uri and an unusually weak COVID-driven Q2 2020 comparison value. The Cass Linehaul Index, our proxy for contract rates, driven by the kink higher in the spot market, closed at a record high of +13.9% Y/Y – taking out the previous high of +9.8% from Q2 2018 recorded during the last inflationary leg of the US TL rate cycle.
As we entered Q2, we brought with us Uri’s surge in March spot market rates with the blended April DAT TL Spot Index ultimately closing at $2.34/mi which was actually 5 cents lower than the March close and made for a preliminary quarterly read of +54.2% Y/Y. At the time we suggested that “given the Uri-driven inflation already baked into the market (i.e. the TL market has arguably been running at produce season rate levels since March), it [was] difficult to foresee a scenario where the market sustains another material leg higher in spot TL rates from [there] – barring another Uri-like event.” And while we did close the quarter slightly higher at +56.1% Y/Y, the entire move came during CVSA Roadcheck the week of May 7th (considered a market anomaly this year given it was postponed in 2020) not from the gradual march higher with the seasonal harvest that we typically see this time of year. In fact, the blended June DAT Spot TL index closed 2 cents lower than May at $2.42. So we expected a relatively uneventful produce season from a spot market rate perspective, and that is largely what we got. Now onto July and Q3.
While Q2’s “produce season that never was” remained the theme all of the way through the end of June, we did get some fireworks the first week of July with a material segment of the driver community choosing to observe the July 4th holiday from somewhere other than the cabs of their trucks. As a result, MTD Spot TL Van rates spiked 11 cents higher to $2.45 by July 6th, but have since faded lower to $2.40 as that capacity returned to market. The blended DAT TL Spot Linehaul Index now sits at $2.48 with both Van and Reefer up by $0.06-$0.07 vs. June while Flatbed is down by $0.03. At these levels, this currently pegs our Q3 TL Spot Market index at +21.6% Y/Y vs. forecast of +10.0%. To settle at forecast, spot market rates would have to fade another 9.5% lower from here, which we believe is entirely possible given the continued rate of net new capacity entering the market. And while Diesel prices continue to march higher, with July MTD’s $3.34/gallon notching +37.0% Y/Y, we do see signs of the growth rate leveling off. But even at these levels, they are not expected to dent motor carrier operating incomes enough to force any capacity out of the market given current spot and contract rate performance.
So as we peer once again into our crystal ball and refine our expectations for the quarter ahead, we continue to focus on the same two wild cards that we introduced last month as the primary drivers for the shape of market through the remainder of the quarter:
1. TL-Intensive US Consumer Spending: This one remains our primary demand-side market force as the pace of the recovery likely slows a bit as the Services sector re-opens, stimulus programs expire, inflation builds, and fed policy begins to tilt more hawkish over the coming months. And now with the rapidly spreading COVID Delta variant threatening the pace of the economic reopening overall, the Services sector could get dealt another blow should virus mitigation measures continue to re-activate across counties and states with trending infection and hospitalization rates.
As a potential signal of such a slowdown, June Manufacturing Industrial Production came in at +7.8% Y/Y, already down to half the surge we got with April’s +15.3% Y/Y. Though it is difficult to tell how much of this came as a result of labor constraints, component shortages, or other supply chain bottlenecks which will likely resolve themselves in the coming months. In any case, with preliminary Q2 GDP and Consumption numbers out next week, we should be in a position to discuss in more detail with more data to work with in next month’s issue. Again, if Durables and Non-Durables hold up, we should see a more gradual Y/Y deceleration lower in TL Spot rates – all else equal. If they do not, we can expect a steeper ride to the inevitable deflationary correction in front of us.
2. Hurricane Season: As we recently experienced with Winter Storm Uri and as already mentioned above, a storm of sufficient magnitude, duration, and geographic impact can have a material effect on the US TL market. Not enough to change the shape of the cycle overall, but certainly enough to create a temporary kink. So as we plunge further into hurricane season, we should all keep this in mind. If we do get another Uri-like event as the 2021 hurricane season unfolds, it remains quite possible that our current inflationary leg gets extended by yet another quarter thus shifting the entire forecast curve forward by a period. Though based on past history, given where we are in the cycle, it would likely take a Category 4 or 5 storm churning along the gulf coast and impacting population centers with active port operations or other supply chain infrastructure like Houston or New Orleans. A swipe at Florida or anywhere along the Eastern seaboard likely wouldn’t do it. Regardless, for those with operations located in at-risk regions, now would be the time to plan for any potential weather-related disruptions should they come to pass in the months ahead. Everyone should be pretty used to disruption planning and resiliency-management at this point.
So after enduring an extra quarter up here on top of our metaphorical TL market cycle roller coaster, thanks to March’s Winter Storm Uri, it appears that gravity has finally caught up with us and our final descent has begun. And barring another catastrophic weather event to delay our journey any further, history suggests that the descent will continue until we hit our deflationary inflection point somewhere in the neighborhood of Q2-Q3 2022. Though given the shape of this particular cycle so far, we almost have to expect a couple more twists and turns along the way. We hope those seat belts are still fastened as we journey further into Q3 as there is plenty of ride left in front of us.