The Baltic Dry Index is setting new highs for the year. This measure of freight shipping costs has often been used as an early indicator in the economy. Because of the global nature of shipping, this index may give a broad take on global economic health but is a less realiable indicator of any specific nation’s economy, particularly a service economy like the U.S. It is thought that much of the rebound in the index is related to Chinese demand for iron ore, and has less direct bearing on our markets.
Perhaps more interesting is the relationship between the Baltic Index and commodity inflation. Consider the chart below, a 20 year history of the Baltic Dry Index (the black line plot) and the Reuters Jefferies CRB index (the red bar plot), a common measure of commodity prices:
The close correlation between the two is evident and logical — over the short run, there is a fairly finite supply of shipping available. The price one is willing to pay for shipping goes higher as the price of the goods shipped increases. There are also some secondary factors that could be expected to influence both measures; for example, since both shipping and commodities are globally prices, a hypothetical weakness in the dollar would move both indices higher.
What’s interesting is not the correlation, but that the freight index leads commdity prices. Doing some very simplistic analysis, the freight index appears to lead the CRB by about 1 to 2 months. This suggests that commodity prices, which have been more range-bound this year, may be ready to move higher. If this is the result of stronger U.S. and global growth, that’s good news. However, if these statistics narrowly reflect, for example, Chinese domestic demand with little spillover effect for our economy, this is bad news. All other factors equal, higher commodity prices lead to lower discretionary spending. We saw rising oil and food prices last spring take a real toll on consumer demand for non-essential goods. With unemployment rising, higher inflation would further hamper the consumer.