What goes up must come down. That is a central law of gravity, and it is mostly true for economic markets as well. Inflation appears to be slowing, if not reversing, for many raw materials and services used in the sawmill and pallet sectors. That’s good news. But the picture is kind of murky when it comes to some aspects of the cost equation.
For example, labor rates remain elevated and are certainly not coming down. The higher wages paid over the past two years appear here to stay. Labor is becoming a much bigger component of total pallet and container production costs. Most pallet companies surveyed by the Pallet Profile continue to report labor shortages. Even if the economy significantly drops over the next year, many pallet companies will likely try to hold onto workers instead of laying off some staff due to higher costs associated with finding workers when orders rebound. These trends suggest that labor costs will remain high unless the U.S. economy goes completely in the tank.
Many other cost components are starting to come down. Diesel prices reached a national average high in late June of $5.87 and have been going down ever since. There has been a slight price spike in September. But prices are still below what they were earlier in the summer. Overall, though, diesel prices remain high compared to last year, now up $1.71 per gallon. Interestingly, gasoline prices have dropped a lot more than diesel and are expected to drop even more as the summer driving season comes to an end.
So, fuel is a mixed bag of lower gasoline prices but elevated diesel prices that remain high compared to this time last year.
Lumber prices are coming down, especially for softwood material, even though many pallet companies are working through older, more expensive lumber inventories. Customers are wanting a price break, but many pallet suppliers are trying to hold steady, concerned about other higher costs. We are hearing reports of more pallet suppliers offering some price concessions to loyal, key customers. But don’t expect pallet prices to go back to pre-pandemic era prices any time soon, if ever. Some higher costs are now just baked into the cake, such as labor, insurance and machinery.
Nails have become more plentiful, and prices have dropped from highs reached earlier in the year. Prices are not likely to return to pre-pandemic levels. But extra supply on the market will likely translate into lower costs.
Insurance rates keep going up and up, especially for property coverage involving pallet facilities. Paul Quandt of Hub International, the largest agency for forest products plants in the country, said, “Rate increases, if you are staying with the same carrier, are seeing high single digits to mid-teens rate increases. If you have to move carriers, you could see premiums double or more.”
Quandt added, “The market right now with pallets is still very hard. We have been seeing carriers that used to cover sprinkler protected pallet operations completely elect to get out of covering the industry nationwide.”
A decade or more ago, pallet companies used to be able to shop around between 8-9 insurers. Now, the industry may only have 2-3 options or less depending on the insured’s history. Carriers are setting loss limits, especially for plants over $10 million in value. For some larger facilities, they have to get layered coverage, where multiple carriers split the risk. This usually adds to the cost as well.
Now, let’s look at the overall economy. What are experts saying about inflation vs. deflation?
Cathie Wood, chief executive of Ark Investment Management, reiterated her view that the economy is in recession and that deflation is the real problem. Wood stated, “The Fed is basing monetary policy decisions on lagging indicators: employment and core inflation.”
Instead, Wood prefers other indicators to look for long-term trends. She commented, “Leading inflation indicators like gold and copper are flagging the risk of deflation… Even the oil price has dropped more than 35% from its peak, erasing most of the gain this year…Gold prices have slid 6% so far this year… Inflation is turning into deflation.”
Ray Dalio, the billionaire investor and founder of Bridgewater Associates, is not afraid to voice his opinion. Dalio remains very concerned about inflation. In an interview with Yahoo Finance, he projected, “I think that most likely what we’re going to have is a period of stagflation. And then you have to understand how to build a portfolio that’s balanced for that kind of environment.” Stagflation can be defined as a period of slow economic growth, increased joblessness and rising inflation.
Still, others are pointing to inflation as the problem, and they want the Federal Reserve to continue along its current track. Mohamed A. El-Erian, president of Queens’ College and economic advisor at Allianz, wrote earlier this summer, “While headline inflation moderated in July, and did so more than widely anticipated, it remains a big problem. Allowed to fester for too long, by the Fed in particular, it is now an entrenched multi-dimensional challenge that has economic, social, financial, institutional and political influences.”
Commenting on some recent core Consumer Price Index numbers, Pooja Sriram, U.S. economist at Barclays Investment Bank, said, “Inflation softened more than expected after months of upside surprises, led primarily by weaker core price pressures. This was driven by deflation in used cars, airline fares, and lodging, while shelter inflation held firm. Although the move is in the right direction, it is too early to say if the trend will be sustained.”
So, what does all of this mean? The Federal Reserve is likely to continue raising rates until it knows it has killed stubborn inflation. According to government data, the annual inflation rate for the United States reached 8.3% in August, down slightly from the previous 8.5% rate. The Federal Reserve has signaled that the key interest rate will end 2022 at a range of 4.25-4.5%. Economists are concerned these rate hikes will certainly cause a drag on the U.S. economy.
Technically, the United States is already in a recessionary posture even if many experts aren’t willing to call it a recession yet. Many economists are bracing for the worst to hit in 2023. Overall, the pallet industry remains strong and will be somewhat insulated from the worst of any downturn to come. In some markets, changing attitudes among consumers and retailers is starting to alter the market from high demand and very tight supply to lower demand and more available supply.
Brambles, the parent company of CHEP, suggested that retailers may start serious destocking of pallets after Christmas. Graham Chipchase, Brambles CEO, projected, “It appears that retailers think after Christmas they’ll start reassessing the inventory levels and moving perhaps more to just-in-time than just-in-case. I think that it could happen a bit sooner because if you think about interest rates, no one’s going to want to hold lots of inventory.”
The good news is that overall pallet demand is expected to continue to grow steadily over the next five years. Those in the pallet industry who have been wanting a bit of a breather may get it. Everyone just hopes any downturn doesn’t last too long.
