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Market consensus is that GRI will be implemented on Sept 1. Market report for Aug 12

By • Aug 13th, 2011 • Category: Containers

The Coracle Container market podcast for Aug 12, 2011 in association with GFI

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Thank you for downloading the container market report podcast from Coracle Online and GFI for August 12th 2011. This podcast will look at the derivative and physical markets.

Starting with the paper market and the Shanghai to North West Europe route and over the past few months, we have expressed our bearish views to the market. The story has consistently been that
the forward curve has been trading in a steep contango. This effectively meant that the differential between the spot rates and the forward freight derivatives was too wide. Given the continuous fall of the index, we did not see the point of buying freight derivatives at a large premium to the falling spot index. The rising index and falling forward curve has now changed our risk assessment for the container derivatives market. The premium of the forward curve over the spot has reduced significantly over the past week and buying freight derivatives now makes sense for shippers who fear of further rises in the index.

Looking at the Shanghai USWC route and its a very similar story to that of NW Europe as the differential between the spot rates and the forward derivative rates is narrowing. From a risk management perspective, it makes sense for shippers to gradually build up some cover by buying freight derivatives to protect against risks to the upside.

Now the physical market and we start with the Asia Europe route where despite many industry participants citing an increase in volumes, capacity utilisation rates are nowhere near the 100%
level that carriers were hoping for. Chinese freight forwarders are telling us that they have no problem finding the required slots in the current “peak season”. Currently there is a flush of activity as retailers are trying to get their inventory in place for the post Ramadan and pre-Christmas season. There were a few announcements by carriers this week for the implementation of a GRI / PSS scheduled for the 1st September of $150 to $250 per teu, following another failed attempt to implement one for the 15th of August. The market consensus is that a GRI / PSS will be implemented on the 1 September, but there are doubts as to whether carriers will be able to pass the full extent of the surcharge through. Looking at the traded contract values for the remainder of
2011 on the SSEFC, it is worth highlighting that the prompt months have gained significantly in value this week.

It’s a very similar story on the Transpacific trade lane to the US West Coast. Another carrier to come under the pressure of the depressed freight market was Matson, who announced the suspension of their CLX 2 China service. The TSA announced PSS for the 15th August does not appear to have taken full effect as the supply / demand imbalance has only narrowed slightly. With many US retailers reporting low inventory levels and a very weak consumer confidence environment, there does not appear to be a short term volume surge from the East for now.

Now some general market comments.
With the turmoil in global financial markets over the past week and fears of a double-dip recession, we wanted to see how this would impact on container freight rates. When the financial crisis hit in 2008/2009, we witnessed global demand coming to a standstill. Freight rates plummeted to record low levels, as volumes dried up due to a complete distrust in the financial system. This occurred because the banks didn’t trust each other’s Letters of Credit. The container industry lost approximately $19 billion in total.

If we consider the current macroeconomic environment to assess the impact this will have on future freight rates then we see that indicators of global economic activity have taken a turn for the worse in the past few months, with indicators such as Purchasing Managers Indices (PMI) and the OECD Leading indicators suggesting that there has been a sharp loss in momentum in activity. This, combined with the turmoil in European sovereign debt markets has created a radical shift in market sentiment. Collapsing equity markets and soaring US Bond pricing suggesting investors have become extremely risk adverse. While it doesn’t appear that we are yet in a recession, the speed at which activity has slowed has heightened the risk that a contraction in activity in major Western economies is not too far away. Manufacturing activity globally was relatively strong at the start of 2011, but an oil price shock and the Japan disasters did impact growth. At the time, these events were seen as only having a temporary impact on activity. It now seems that there was a loss of economic momentum unrelated to these events, particularly in the US. Indicators of European growth have also been poor. The loss of momentum in growth has exacerbated the pressures currently being place on sovereign debt in the Euro zone. The crisis has spread beyond the smaller periphery economies, with Italian and Spanish bond markets under attack and France’s credit rating also under threat. Intervention by the ECB has bought yields down, but this is not a permanent solution. A further spike in yields could push some of these major economies towards default, which would be a catastrophe for the Euro and would have severe consequences for the global financial system. While banks, corporates and households are generally in a better financial position than in 2008, we could still see a severe shock that would impact global growth.

The debate around the debt ceiling and the S&P downgrade of the US appear to be the least important event of the last few weeks. Investors are now willing to pay the US government to keep their money in inflation adjusted bonds, which suggests investors are not at all concerned about the solvency of the US government. The US fiscal position will be a problem somewhere along the line, but it’s not in the here and now.

Notably absent from most recent financial commentary has been developments in China. Of significance has been the NDRC’s admission that inflation has probably peaked, while a communique from Premier Wen has suggested that concerns are shifting towards growth and away from inflation. This should see credit becoming more available heading into the end of the year and should support better activity. But better Chinese growth may not be enough to save pricing for some commodities and freight rates, with freight susceptible to weaker activity in both the US and EU. In an environment where activity is likely to undershoot expectations, it may be prudent to consider hedging rates on some trade lanes. Shippers may consider using options or outright swaps to protect their upside. This is especially true for shippers with tighter supply chains who will benefit from the use of freight derivatives, as it will eliminate the chance of containers getting rolled over. Both carriers and shippers should take heed of lessons from the recent past and take advantage of the available hedging tools in the industry.

Thanks for listening