[Excerpt from The Pickett Line March 2022 Issue]
And that’s a wrap ladies and gentlemen. Q1 is now officially in the rearview mirror. To say that a lot has happened over the last three months would be a colossal understatement. Looking back as we close out this first quarter of 2022, let’s take some inventory. We kicked off the new year with a rapid surge in Omicron variant infections across the US that thankfully collapsed and dissipated by late February, but in the meantime resulted in a wave of acute staffing shortages across every segment of the supply chain – be it retail, manufacturing, warehousing and distribution, and transportation…including truck drivers and support personnel. We then compounded that with a string of disruptive winter storms that impacted virtually every region of the country at some point, most of them significant enough to be named. And finally, just when it appeared that global supply chains might have a chance to stabilize and recover, we got an unprovoked Russian invasion of Ukraine to bookend the quarter. Well, that and inflation surging to 40-year record levels and now threatening what we had hoped would be a robust post-COVID US economic recovery.
So here we stand. On one hand, we have a newly united West working to support the Ukraine defense and humanitarian relief efforts and suppress the Putin regime without somehow triggering World War III. And on the other, we have Jerome Powell and US Fed working to tighten monetary policy to combat rising inflation and engineer a soft landing for the economy without triggering the next recession. And if that wasn’t enough, given we’ve run out of proverbial hands, we have a new Omicron BA.2 variant that has already spread rapidly across the globe and is now the dominant strain in the US. So yeah, there are plenty of reasons to be worried in the months ahead. That said, there is plenty to be optimistic about too. Unemployment rates are at record lows, COVID mitigation policies appear to be unwinding across the country, kids back in school, and household balance sheets have arguably never been healthier. If an economic downturn is indeed around the next corner, there is little doubt that a swift recovery will soon follow. And it is this idea of a downturn followed by a recovery that serves as an apt segue as we shift gears to unpack the aggregate impact of all of this to the US trucking market in this March 2022 issue of The Pickett Line.
While March tends to be a relatively quiet month with regard both to market seasonality and new economic data to consider, this one has been anything but. As discussed last month, the US TL Spot Linehaul cycle had been decelerating steadily since Q2 2021 as the market shifts from a state of relative supply scarcity to relative supply abundance. Yet that trend was interrupted in Q1 2022 with a slight kink higher in Y/Y TL spot linehaul rates, likely due to the Omicron and weather-related disruptions in January and February mentioned above. However, it was expected that it was only a matter of time before the market broke lower in compliance with the historical supply vs. demand cycle. And that time came this month, with DAT national average Van and Reefer rates dropping 21 cents (-8%) and 27 cents (-9%) M/M, respectively. Yes, diesel prices spiked +27% over the same period, which explains some of this weakness in DAT’s implied linehaul rates, but not enough to halt the overall descent. Flatbed rates, on the other hand, rose 4 cents (+2%), which could be an optimistic signal for the underlying strength of the US economy, but the flatbed segment represents such a tiny sliver of the US trucking industry that it has little to no impact on the TL market as a whole.
So as we close out Q1, the final read on our US DAT TL Linehaul Spot Index sits at +17.8% Y/Y ($2.65) as compared to last month’s +21.3% and 7.1% higher than our forecast of +10.0%. We didn’t quite close the gap to break below +15.0% and resolve our pesky cycle kink but we did cover over the half the distance with momentum likely to continue driving spot rates still lower from here as historical patterns resume. We maintain our forward-looking guidance through the remainder of the year with next quarter expected to close somewhere in the neighborhood of -10.0% Y/Y (-18.5% Q/Q) making it our first Y/Y deflationary quarter in two years and the beginning the final leg of this current US TL spot market cycle.
Last month we noted that perhaps ironically, inflationary diesel over the short-term could ultimately hasten the Y/Y deflationary collapse in the TL Spot market. It appears that so far at least, that has indeed been the case. And the market dynamics behind this are counter-intuitive enough that I think the explanation bears repeating. 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 ($5.185/gal this week) 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. Therefore, we tend not so see as direct of a relationship from a rate of change standpoint. In other words, this is not simply a ‘cost-plus’ market environment.
We went on to comment that “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 load boards that then feed 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 estimated industry per mile operating costs, there is plenty of room below for the market to seek a new floor.” Looking back now a month later, that is pretty much what appears to have unfolded. And the role of diesel from here on out will likely only be in helping to set the deflationary floor at which we ultimately find our next TL spot market inflection point. If diesel corrects materially lower by the end of the year, which it very well could, we could see a deflationary inflection point even lower than current forecast.
And speaking of Contract rates, you will probably notice a pretty dramatic revision to our Q1 Cass Linehaul Index read (our proxy for the US TL Contract market) compared to last month’s +6.4% Y/Y. Our February revised read of +11.9% comes as a result of Cass miscalculating the January index value and not disclosing the error until the February release – taking January from 150.2 to 158.0 and showing February flat at the same 158.0 level. So instead of showing right in line with our Q1 forecast of +7.5% Y/Y, we now have a kink setting up that is comparable to the one we observed in our spot market index over the same period. That said, we probably should have known something was fishy last month given the conspicuous divergence in the two lines with Cass Linehaul bending lower despite DAT US TL Spot Linehaul Index kinking higher Y/Y. Regardless, we expect both to snap back to forecast next quarter and Contract rates to break Y/Y deflationary as early as Q3.
While we will have to wait until preliminary Q1 2022 GDP is released at the end of April for the next update on the heated battle for post-COVID US Consumer wallet share between Goods (Durable and Nondurable) and Services, we did get a final revision on Q4 this month. Overall GPD gave up 10 bps to close at +6.9% vs. 7.0% annualized from the last revision. Aggregate Consumption revised lower as well, from 7.0% to +6.9% Y/Y – with Services shrinking 20 bps to +6.7%, Nondurable Goods gaining 110 bps to close at +7.8%, and Durables holding flat at +6.7% Y/Y. So a little bit of movement but all remain clustered in the same +6-8% Y/Y range for the second quarter in a row. May a Champion be crowned when we report the April update in our May issue, as the drama is getting almost unbearable. Or maybe that’s just the WrestleMania-inspired storyline we have concocted around this particular narrative that is getting unbearable. In any case, we look forward to a resolution soon.
Now onto US Industrial Production where we also saw a slightly lower revision to +5.1% Y/Y on the quarter, compared to last month’s +5.2%. We continue to see at least some evidence of stability in the ~+5.0% range and a reversal in the deflationary trend in place since spiking to +14.7% Y/Y in Q2 2021 as the economy rebounded from the Q2 2020 COVID recession. Though at this point, it is difficult to get a sense as to whether this does indeed represent a potential change in trend or is merely a brief pause before decelerating lower. We’ll find out either way in the months ahead.
Moving on to Inventory levels, we got our first glimpse at Q1 with the January read on the Inventory to Sales Ratio coming in at 1.25, compared to last quarter’s 1.26. Given the narratives around a potential overshoot in retail and wholesale purchasing during last quarter’s peak retail season to mitigate against global supply chain disruptions and potential stockouts, we had expected this number to come in somewhat higher as a signal that inventory levels were finally rebuilding after the historic run on goods consumption throughout the pandemic. But so far at least, any sign of the bullwhip effect rearing its head once again is not showing up in the data. We look forward to getting the February read later this month to hopefully show some signal either way.
Now onto US TL volume demand where we have an interesting pattern continuing to form in the crossover of our two primary indicators, which in the past has signaled the beginning of the deflationary leg of the US Spot TL market cycle. Our February revised Q1 Cass Shipments index corrected higher to -1.8% Y/Y vs. last month’s -5.9% yet remains poised for the first Y/Y deflationary close since Q3 2020. But we’ll have to wait until the March number is released later this month to know for sure. Trending in the opposite direction, our second volume indicator, the ATA TL Volume Index is signaling its first potential Y/Y inflationary close since Q1 2020 at +0.4% Y/Y with its February revision, compared to last quarter’s -1.2%. Recall that one of the more interesting story lines in recent months 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 with March’s revisions, we will see the crossover confirmed 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. We commented last month that this “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.” After the recent plunge in the spot market however, it has gotten markedly easier.
Moving on to the first of our Supply indicators, Net Class 8 Tractor Orders remains perhaps the greatest head scratcher of them all in this cycle. We have remarked consistently in past 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 go Y/Y net orders so go 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 Net 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 reported in recent months than diminished appetite for new capacity.
And with the historic correlation breaking down the last two quarters, with Class Net Orders coming in at -61.1 Y/Y in Q4 and revised slightly to -49.7% Y/Y this Q1 while TL Spot Linehaul rates remained decidedly inflationary at +15-18%, that argument certainly has some data to support it. However, we propose that should our DAT TL Spot Linehaul index close anywhere near our forecast line in the quarters ahead, much of the narrative around this time being different will be proven mostly misguided.
And finally, on to diesel costs and the global energy market. After breaking over the $4 threshold for the first time since May 2014 last month with February’s $4.032/gallon, March took it a notch higher with $5.105/gallon – the first read over $5 since…ever, taking out the previous July 2008 record of $4.703. Where energy prices go from here will arguably be dictated by how Russia’s invasion of Ukraine is ultimately resolved and supply’s response to these historically elevated price levels – both commercial suppliers and governments themselves. We pondered last month “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?” With President Biden’s recent announcement that the US would release one million barrels/day from its strategic reserves over the next six months while domestic producers ramp up incremental supply, it looks like it turned out to be about a month. As to how all of this will impact the movement of diesel prices in the month ahead as the tragedy in Ukraine evolves, only time will tell. Regardless, we don’t believe that inflationary diesel costs – even at these historic levels – will materially disrupt the US TL Spot market cycle given the historic level of linehaul rate inflation currently baked into the current market.
So while Q1 is now thankfully behind us, our 2022 crystal ball remains cloudy at best given our dynamically shifting geopolitical environment and decidedly uncertain US macroeconomic outlook. But just beneath that haze, the future path of US TL Spot & Contract Linehaul rates has gotten increasingly clearer as recent market anomalies have begun to resolve themselves. And last month’s short list of wild cards that we believed would shape the quarter ahead is still just as short, and still in the same order as we look to April and the quarter ahead – which we hope to remain the case for at least another month (I’m looking at you Omicron BA.2). Let’s revisit them here:
1.Russia’s Unprovoked Invasion of Ukraine: As the range of potential consequences to both the Demand and Supply sides of the US Trucking market continue to reveal themselves, what comes next remains difficult to predict with any certainty at this point in the conflict. The most direct impact has come from the rapid spike higher in diesel prices, which we have already addressed. Should diesel surge still higher from here, the breakeven point for motor carriers rises and we likely see our deflationary inflection point sooner. And should they correct lower, we get the opposite effect and Spot Linehaul rates ultimately run lower for longer. So far, the impact of cyber warfare on the market has been negligible at best. But will that remain the case should the conflict escalate? And finally, the ripple effects from supply disruptions across markets that deal in Russia’s other primary exports like natural gas, aluminum, nickel, wheat, and potash fertilizer continue to play out. 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: Just when it seemed as if we were over the hump with the COVID-19 pandemic, here comes runaway inflation, rising interest and mortgage rates, and a war in Europe to takes its place to challenge consumer confidence and the overall propensity to spend. As the Fed turns increasingly hawkish in the months ahead as it seeks to rein in inflation and keep the economy from overheating, Consumers will no doubt feel the pinch across a range of fronts. And with less discretionary income available to start with, the relative shift in consumption patterns from goods to services could be even more pronounced – which is certainly not constructive for US truckload transportation demand. We de don’t expect demand to go off a cliff by any means, just that it is likely to continue slowing relative to last year. But as with much of what we have covered, only time will tell.
And now as we stand on the precipice of what we expect to be a steep drop in Y/Y US TL Spot Linehaul rates in coming quarters, it remains as important as ever not to panic or overreact. If you’ve been paying attention over the last few months, you should be well prepared for what comes next.
As Spot rates continue to break materially lower as compared to Contract rates, we likely see a continued rise in primary tender acceptance across most Shippers with contract-eligible truckload freight – not because of anything that the procurement or operations organizations have done differently, but because more attractive options for Motor Carriers or Brokers increasingly cease to exist. Service levels generally improve and the rate at which Carriers or Brokers give back previously accepted load tenders decreases materially. Nobody in procurement gets fired or forgoes their target bonus for blowing the freight budget this year – at least not the linehaul component. Fuel spend may be a different story. Then as we get further into the cycle, a tsunami of mini-bids and more than a few complete re-bids will be unleashed by contract Shippers that seek not to renege on previously awarded contract freight, but only to ‘adapt and re-calibrate to an increasingly dynamic market environment’ – a term which they are all-too-familiar with from the wave after wave of supply-driven re-contracting that occurred in 2020-21. Additionally, as Spot rates continue to fade lower and Contract rates are reset, many of those recent investments in standing up or growing private fleets or expanding dedicated fleet contract commitments will begin to look ill-advised in retrospect relative to the broader market – so expect some reshuffling there.
Contract-biased TL Carriers and Brokers will keep their fingers (and toes) crossed in hopes of retaining their awarded contracts for as long into the term as possible. Spot-biased service providers will find themselves increasingly out of position and work feverishly to increase contract exposure, if they have the capability to do so, by any means necessary as spot opportunities gradually dry up – which helps trigger the mini-bid tsunami mentioned above. For spot-biased providers that are unable or unwilling to service contract commitments, times get increasingly tough as the market seeks to restore equilibrium one way or another. And unless an explosion in new demand shows up to save the day, that equilibrium can only come from surplus supply eventually exiting the market. So the name of the game will be survival. And the key will be in maximizing the revenue opportunities that do exist by seeking longer haul freight to minimize the total number of loads required to max out on a weekly basis, though that may present other challenges should diesel prices continue to rise. An alternative strategy may be to go the other way entirely and seek out more shorter haul loads that pay more per mile but can be strung together to create attractive weekly routes. Or if one can find higher-paying shared truckloads or multi-stops out in the marketplace where the routing work has already been done, even better. And finally, shipping air will never be more expensive than it is in the months and quarters ahead for the average motor carrier, at least in terms of the relative opportunity cost and the importance of maximizing utilization. So if partial shipments can be found to top off with or otherwise combine with other partials that increase total load profit, that could be another way to generate more revenue per week as well.
So as economic conditions remain uncertain at best while the pace of commerce only accelerates and the US TL Spot Market prepares to enter its first Y/Y deflationary leg of the market cycle since 2019, speed to market remains king and the case for collaboration among trading partners and across the global supply chain to reduce system waste only grows stronger. And this applies to both the Demand (Shippers) and the Supply (Carriers & Brokers) sides. Those that can recognize an attractive demand signal and position their organization to fulfill it the fastest and most efficiently will just plain outperform slower moving operators. And in a shifting marketplace that seeks equilibrium by weeding out unprepared or unfit competitors, it will be very much about the survival of the fittest. So may the fittest not only survive but thrive over the balance of the year ahead. Because we’ve all had plenty of time to prepare and position. And those that most effectively navigate the deflationary leg in front of us and get faster, stronger, and more disciplined in the process will benefit most as the market recovers, the cycle resets, and rates surge higher Y/Y once again by late 2023.