[Excerpt from The Pickett Line February 2022 Issue]
My what a difference a month can make. Now two thirds of the way through the first quarter of 2022, we find that the global supply chain still can’t get a break. The good news is new Omicron infections in the US have plummeted over 90% from peak levels of +800,000 daily cases on January 15th. The bad news is we now have an unprovoked Russian invasion of Ukraine to contend with, effectively replacing one humanitarian tragedy of epic proportions with another. Thanks Putin, this is why we can’t have nice things.
So as much of the free world rallies to Ukraine’s cause and as many contemplate what comes next with regard to geopolitics and the new world order, we will try to remain focused on the potential implications to the US Trucking industry in the months ahead. All else equal and when all of the puts and takes are accounted for, is this most recent development likely to drive US truckload Spot linehaul rates higher or lower? As with most questions in this industry, it’s complicated. So in a month already loaded with fresh macroeconomic and market data to examine – specifically Q4 Consumption and Imports in addition to our first peeks at Q1 Industrial Production, the Cass Shipments Index, and the Cass Linehaul Index, we now have a war in Europe to try and account for in our analysis. So with that as our backdrop, let’s get started.
After closing Q4 2021 at +15.0% Y/Y and coming into Q1 unexpectedly hot at +24.4% in last month’s update, driven higher by an Omicron overhang and winter weather-related disruptions, the revised read on our Q1 DAT US Truckload Spot Linehaul Index now sits at +21.3% Y/Y. For further context, national DAT van rates surged 15 cents/mile from the December close to peak on January 14th at $2.75/mile – and have been fading lower ever since, albeit slowly. January ultimately closed at $2.70 and rates currently sit at $2.65 for February month to date. That said, we also have to keep in mind that DAT’s fuel surcharge adjustment has jumped 5 cents from the beginning of the year which accounts for almost half of the move in implied linehaul rates. In any case, it remains our view that the current kink in the Y/Y DAT TL Spot Index chart will resolve itself by quarter close, which would require that the final read settle lower than last quarter’s +15.0%. This means that the slide in TL spot linehaul rates lower would have to pick up some steam through March. Certainly, Russia’s war in Ukraine and the crippling economic sanctions on Russia that are no doubt coming as a result add a new wild card. But even with the material inflation in diesel prices we might see in the weeks ahead, we believe that the net balance of truckload supply vs. demand has already tipped high enough that market forces will continue to push spot rates sequentially lower through the balance of the year.
Ironically, inflationary diesel over the short-term could ultimately hasten the Y/Y deflationary collapse in the TL Spot market. Consider that a majority of Contract TL rate agreements in the US include a fuel surcharge component that typically adjusts weekly based on the national average on-highway price at the pump (dollars per gallon) as reported by the US Department of Energy or assessed by some other means. So in an inflationary diesel environment, all-in Contract TL rates will rise steadily and in lockstep. And the faster that diesel prices move higher, the faster those all-in Contract rates move higher as a result. In the Spot market however, rates are driven by a variety of factors – of which the cost of diesel is only one. So we tend not so see as direct of a relationship from a rate of change standpoint. Therefore, if diesel does ultimately charge higher from here, all-in Contract rates will look that much more attractive than comparable Spot market rates. Primary tender acceptance rates from the carriers and brokers that sit atop their respective Contract routing guides will surge higher as a result which means less freight makes it to the Spot market. And with fewer loads available to feed the Spot-biased segment of the supply base (i.e. freight brokers and the +100,000 small carriers that entered the market with new authorities in 2021), competition for those loads will likely drive Spot rates even lower – all else equal. And with current Spot market rates sitting well above industry per mile operating costs, there is plenty of room below for the market to seek a new floor. So shouldn’t rising fuel costs drive US Spot TL rates higher? Like we said at the top, it’s complicated.
And while we’re on the subject of Contract rates, we got our first glimpse at Q1 with the January read on the Cass Linehaul Index (our proxy for US TL Contract market rates), which came in at 150.2 or +6.4% Y/Y – compared to last quarter’s +9.9% and our Q1 forecast of +7.5%. And while we can’t draw too many conclusions based on this early data point alone, the trajectory so far continues to track very closely to our forecast line. Should that remain the case in the months ahead, we should then expect to break Y/Y deflationary as early as Q3 of this year.
Now onto some of the macro data that we teased last month as we characterized the ongoing battle for post-COVID US Consumer wallet share between Goods (Durable and Nondurable) and Services as a WWE WrestleMania event complete with steel chairs and leg drops off the top rope. With the Q2 Y/Y COVID correction in the economy finally behind us as confirmed by the Q3 reads, we were anxiously awaiting the preliminary Q4 numbers released January 27th (then revised February 24th) to get our first real signal as to the direction in consumption patterns from here. And with the revised Q4 read now in, we regret to inform you that no such signal was received – all came in basically flat Y/Y relative to Q3. What a letdown! …much like most actual WWE WrestleMania events these days. Services lost a measly 30 basis points (bps) to land at +6.9% Y/Y while Durables gained 40 bps on its way to +6.7% and Nondurables picked up 50 bps to close slightly higher at +6.7%. So all three components remain clustered together at +6-8% Y/Y for the second quarter in a row – yes, very anti-climactic. Aggregate Consumption closed an even more measly 10 bps lower at +7.0% Y/Y relative to Q3. Which only means that the Consumption battle rages on and we’ll now have to wait until after Q1 posts in late April for any potential resolution. So stay tuned for the May issue for our next opportunity to crown a 2022 US post-COVID wallet share growth Champion – be it Goods or Services.
We also got our first Q1 read on Industrial Production with the January release, which came in at +5.2% Y/Y – slightly higher than Q4’s +4.6%. At this point, it is difficult to get a sense as to whether this represents a potential change in trend or merely a brief pause before decelerating lower. In any case, we look forward to finding out in the months ahead.
After last month’s revised November look at the Q4 Inventory to Sales Ratio showing 1.25 (up slightly from the prior month’s preliminary read of 1.24), we commented that by reporting lower than Q3’s 1.26, it appeared that a bottom perhaps had yet to found as inventory levels continued to fall behind relative to sales. With December now in and the quarter fully baked, Q4 picked up another bp to close at 1.26, flat with the prior quarter and confirming 1.25 in Q2 as the current bottom to the 2020-21 run on inventories to meet the COVID-induced surge in demand for Durable and Nondurable Goods. And given the reported spike higher in the Change in Private Inventories as the leading contributor to Q4 GDP growth, we expect the bottom to hold and Inventory to Sales to build steadily higher from here and through the balance of the year. Generally speaking, a rising Inventory to Sales Ratio tends to have a deflationary effect on Industrial Production unless Consumption is rising even faster. However, given the numerous headwinds in play – historic inflation levels likely to spike even higher as a result of Russia-Ukraine, a rollback in government stimulus spending, and the specter of rising interest rates making debt more expensive to service, accelerating Consumptions levels in the months ahead seems unlikely.
Now onto US TL volume demand. Recall that last quarter, the Cass Shipments Index closed roughly in line at +4.3% Y/Y with Industrial Production’s +4.6%. With the January read on the Cass Shipments Index now in, we see that the convergence didn’t last long. While representing only our first preliminary peek at Q1 and it being a month impacted materially by Omicron-related staffing shortages and extreme winter weather disruption, if it ultimately lands anywhere near the current -5.9% Y/Y, we’ll have our first deflationary close since Q3 2020. And given where we are in the US TL Spot Market rate cycle, the direction of US TL Demand and this indicator specifically may be the most instructive as to what lies ahead.
Our second volume indicator, the ATA TL Volume Index ultimately closed Q4 exactly where it started at -1.2% Y/Y, recovering slightly higher from the November revision to -1.9%. Recall one of the more interesting story lines from last month revolved around the continued convergence and expected eventual crossover of our two TL Demand indicators with Cass Shipments collapsing lower while ATA TL Volume trended slowly but steadily higher. If the current trajectories hold, we could see the crossover this quarter. From there, we believe we could get a repeat of 2019 where the Cass Shipments Index ran decidedly Y/Y deflationary with Spot TL rates while the ATA TL Volume Index broke decidedly inflationary as unprofitable carriers eventually began idling capacity or exiting the market altogether. As noted last month, that scenario is difficult to envision with TL Spot rates still lingering +21.3% higher Y/Y, but this is exactly where history suggests we’re headed. Time will tell.
Now onto Net Class 8 Tractor Orders, perhaps still the greatest head scratcher of them all in this cycle. We have remarked in recent issues that net tractor orders had proven to be perhaps the most consistent signal over past US TL cycles. Across the last four complete cycles observed since 2007, both the US TL Spot Index and Class 8 Net Tractor Orders have flipped Y/Y deflationary in the same period (plus or minus a quarter) as the cycle transitioned from its inflationary leg. Just like clockwork, as goes Y/Y net orders so goes US TL Spot linehaul rates. But with the continued supply chain constraints faced by the Class 8 OEMs this cycle, arguably entirely unprecedented as compared to past cycles, it is easy to make the argument that things are indeed different this time around – that Class 8 Orders as a directional US TL Spot market indicator can’t be trusted. And that negative Y/Y Net Tractor Orders have more to do with a record +14-month OEM order backlog than diminished appetite for new capacity. The reality is that it’s impossible to know the answer to this with any real certainty from where we’re currently standing. But hopefully we get some signal in the months ahead and can pontificate with more conviction soon. Until then, we will continue to monitor and map relative to historical behavior. With Q4 closing Y/Y deflationary for the first time since Q2 2020 at -61.1% Y/Y and January’s preliminary Q1 on the board slightly higher but decidedly deflationary at -49.3%, the stage continues to be set for a Y/Y deflationary US TL Spot market in the very near future – but only if history continues to rhyme with regard to this particular indicator.
And after touching on inflationary diesel costs already as one of the likely short-term consequences of the Russian invasion of Ukraine last week, let’s mark our pre-war baseline here with February’s month to date read at $4.008/gallon – the first time the national average has broken the $4 threshold since May 2014. But while this takes the Q1 average up to +33.3% Y/Y (vs. last month’s +25.6%), we remain well under the current Q4 2021 cycle peak of +48.5%. But with an incredibly uncertain period of war, sanctions, and global macroeconomic shifts ahead of us, it’s anyone’s guess as to where diesel goes from here. Higher in the short term seems like a pretty safe bet, but how high and for how long? At what point does Supply conspire to intervene as a result, with historically higher-cost producers spinning up new capacity or governments stepping in with expanded regulatory support to reduce future dependency on Russian oil and natural gas? And the net impact on US TL rates is also far from obvious given the perhaps counter-intuitive impact this could have on Spot vs. Contract TL rate dynamics as the story unfolds – as we outlined earlier. While higher diesel costs absolutely mean higher all-in Contract TL rates in the short term, the same cannot be said for Spot rates given where we are in the cycle.
So while the global market landscape continues to shift beneath our feet on a near daily basis, the short list of wild cards that we believe will shape the quarter ahead has actually gotten even shorter relative to last month. With Omicron thankfully now having run its course and the risk of extremely disruptive winter weather events diminishing the further we get into the calendar year, we can strike those from the list. And as inventories continue to rebuild, global supply chains begin to stabilize, and manufacturers adapt to prevailing market conditions, we also no longer see widespread COVID-driven Supply Chain Shortages playing a starring role in the US TL Spot market story going forward – so we’ll strike that one as well. That leave us with TL-Intensive US Consumer Spending from last month and the obvious new entry to the list with Russia’s invasion of Ukraine – be it the potential inflationary pressures driving diesel prices higher and consumer spending lower or disruptions in the physical movement of goods from sanctions, cyber warfare, and potential escalation of the conflict altogether. Let’s dissect them further here:
1. Russia’s Unprovoked Invasion of Ukraine: As touched on above, the range of potential consequences to both the Demand and Supply sides of the US Trucking market are far reaching and difficult to predict with any confidence at this point in the conflict. If the cost of energy overall spikes higher as a result of US sanctions, diesel prices at the pump obviously rise taking up all-in trucking rates with them – immediately in the Contract market and over a longer period of time in the Spot market, all else equal. The spike higher in inflation for the Consumer is also likely to have a negative impact on spending in the months ahead, further hampering the rate of the post-COVID economic recovery and the truckload transportation demand that supports it. A potential rise in cyber warfare, depending how things escalate from here, certainly won’t help things either with regard to overall supply chain continuity and stability – just ask anyone impacted by the recent ransomware attack on Expeditors International, whose systems have yet to be restored over a week after taking them offline in defense. On the other hand, we could see a renewed national interest in domestic energy investments to ensure long-term independence from foreign suppliers – of which Russia is now global public enemy number one. This could result in increased domestic production across a variety of sectors, which would of course be positive for US truckload demand. In any case, this one will remain top of mind and at the top of our wild card list as the tragic situation develops.
2. TL-Intensive US Consumer Spending: As noted, most market indicators remain mixed on just how much goods-related spending we should expect to see in the months and quarters ahead – with Q4 Consumption data offering no meaningful guidance. With inflation proving to be less transitory than expected (and likely to be fanned even higher after Russia’s invasion of Ukraine) and fed monetary policy shifting increasingly more hawkish as a result, even with the rapid demise of the most recent Omicron wave and the promise it holds for a post-COVID reopening of the economy after two long years, war in Europe has stepped in to kick a new dent in Consumer confidence. While we still expect Goods related consumption to continue decelerating in the months ahead, we are now less constructive on how much of that spend migrates over to the Services sector in the short-term. And if Consumption across all sectors slows down from here, the deflationary impact on US Truckload demand could be even more significant than expected just a few weeks ago.
Well, last month we claimed that while we make no guarantees that 2022 won’t be every bit as chock full and challenging as the last year, the US Truckload cycle at least suggests much calmer waters ahead. We certainly didn’t have an unprovoked war in Europe and a potential shift in the new world order in mind at the time, but our claim stands nonetheless. Regardless of what may or may not happen in the energy markets or the global supply chain in the near future, we still expect both US Truckload Spot and Contract market linehaul rates to decelerate through the balance of the year – albeit at different paces. We still project spot rates to bend negative Y/Y next quarter and contract rates to follow a quarter or two later before reaching Y/Y deflationary territory by the back half of the year.
So as the 2022 US TL Spot Market roller coaster careens forward into the unknown, now more than ever, it pays not to panic. All of the themes that we have reinforced over the past year in response to violently shifting consumption patterns, cascading inventory and labor shortages, and congestion and disruption across virtually every link of the supply chain remain relevant. There remains a need for speed throughout every network. Those positioned to detect meaningful market signals and respond quicker than the competition will win. Those that have invested in building flexibility and optionality into their transportation and distribution platforms will win. Those that have built high-velocity organizations, supported by the necessary technology solutions to enable supply chain visibility and control, will win. And most importantly, those that have chosen their supply chain partners wisely and invested in those relationships for long-term mutual success will win. So stay agile, stay flexible, and stay resilient. Onward to March.