Why Higher Than Expected U.S. Inflation Data Might Persist: Red Sea Disruptions and Increased Foreign Investment in the U.S.

Disruptions in the Red Sea have elevated freight costs and elongated supply chains, adding incremental costs to commodities, energy, and physical goods. Moreover, shipping utilization rates have spiked, creating a more fragile supply chain. The economy is no longer able to handle incremental volumes or negative supply-side shocks without outsized impacts on cost (inflation).

Increased foreign investment in the U.S. may warrant a prolonged period of higher interest rates. Could incremental foreign investment in the U.S. offset the impacts of the higher cost of borrowing on domestic investment? Strategic advantages across security, geography, natural resources, and demographics may make the U.S. a particularly compelling developed economy to invest in over the next 5-10.  

How is the Red Sea Shipping Disruption Developing?

The Houthi attacks are unabated in the Red Sea. U.S. Central Command has reported proactive strikes against Houthi launch sites, defensive strikes against Houthi attacks, and successful Houthi attacks on transiting ships with minor damages. As we highlighted during the U.S. initial strikes versus the Houthi, the Houthi’s guerrilla-style warfare is unlikely to be prevented. The graph below demonstrates Suez Canal vessel transits per day; the right-hand side shows the percent change in transits by segment.  

Will The Houthi Stop or Be Stopped?

A resolution seems unlikely in the near term. Stopping Houthi attacks requires drying Houthi weapon stockpiles and Iranian weapon inflows. The timeline required for this is unknown. A ceasefire in Gaza has been ruled out. An Israeli invasion of Rafah to destroy the four remaining Hamas brigades in the Southern city seems almost certain. Israel may have broader security objectives on the horizon.

Will the IDF Attack Hezbollah After Hamas?  

We’d assess a greater than 80% likelihood the IDF’s operational success in Gaza will be followed by escalation against Hezbollah to degrade Hezbollah’s offensive capabilities. Tensions continue to mount on Israel’s northern border with Hezbollah. A barrage of Hezbollah rockets fired towards Israeli territory this week killed one. Shortly thereafter, Israel hit a Hezbollah Commander in Lebanon with an air strike (Read More About Hezbollah’s Attack). 

Why Rising Geopolitical Risk May Spur Increased Investment in the U.S.?

Geographical advantages benefit the U.S. in conflict. The Atlantic and Pacific keep U.S. advisories oceans away, while the U.S. has major strategic outposts bordering Russia, Iran, North Korea, and China. War won’t create any winners; however, the first large U.S. losses are most likely to occur on foreign soil. The first U.S. adversary losses will almost certainly occur in the opposition’s homeland. The distance advantage may give the U.S. time to resolve conflicts and/or leave it in the best position to rebuild.

The U.S. has made robust investments in defense, while many of its allies have long underspent on defense. The U.S. is a leader in the defense sector. Many U.S. allies find themselves in a hurry to increase defense budgets and war readiness. The rapid need for defense spending hikes abroad may draw from more economically beneficial government spending in the respective nations.

What Other Factors Does the U.S. Benefit From?

Energy: The U.S. has quietly become the largest LNG exporter and Oil producer in recent years. The U.S. land has large reserves and has been more heavily invested in. The U.S. is a net exporter of energy. Russia and Norway are the only net energy exporters in Europe and Indonesia is the only in Southeast Asia. Southeast Asia, China, and Europe are overwhelmingly dependent on energy imports. China, India, Japan, South Korea, and Japan are the five largest energy importers (Read More from the IEA).

Land/Agriculture: The U.S. has a relatively low population density, suggesting it has room for expansion. The U.S. is also a net exporter of food. As such, population expansion can be supported domestically (Learn More About Agriculture Export/Imports). 

What Evidence Shows the U.S. Economy Is Holding Up Differently Than Others?

U.S. economic data came in weaker than expected this week. Although, U.S. economic resilience has been noteworthy compared to other major economies. Both Japan and the U.K. officially entered a recession. China’s economic hardships were covered last week. Strategic advantages and economic resilience may drive foreign investors towards U.S. markets, which has the capacity to grow despite higher borrowing costs.