This week in Bidenomics: US airstrikes target inflation, too

The Middle East war is widening, but that may be better than the alternative: new inflationary pressure from an obscure fundamentalist militia 8,000 miles from US shores.

The US and UK militaries finally struck back at Houthi forces in Yemen on Jan. 11 and 12, in response to at least 27 Houthi attacks on commercial ships navigating the Red Sea between northern Africa and Saudi Arabia. There were legitimate military reasons for the retaliatory strikes, given that the Houthis have targeted US and allied forces, including Israel. But there was a powerful economic incentive too: The attacks on commercial vessels were starting to drive up shipping costs and threatening to reignite inflation, just as the Biden administration feels it is finally taming the biggest barrier to a second term for President Biden.

The Red Sea is a crucial shipping lane because the Suez Canal, at its northern tip, connects waters that serve Western markets with the Indian Ocean and routes to Asia. Ships unable to transit the Red Sea need to take the much longer and costlier journey around the southern tip of Africa. About 15% of world trade transits the area.

The Houthis, backed by Iran, started shooting at some of those ships after Israel invaded Gaza in the aftermath of the Oct. 7 Hamas attack on Israel. The Houthis say they’re targeting ships bringing cargo to or from Israel, but they’ve also targeted ships with no obvious connection to Israel. Until the Jan. 12 strikes, American forces were mostly playing defense, shooting down Houthi missiles and drones and, in one instance, sinking three boats that fired on US helicopters.

The Pentagon says US and British forces struck 60 Houthi targets at nearly 30 sites using more than 150 bombs and missiles. The strikes were meant to disable the Houthis’ ability to conduct further strikes on commercial ships. The Houthis say the attacks will continue. President Biden says that if they do, US forces will take out more Houthi targets.

Biden and his security team have obviously been reluctant to broaden the Middle East war. But now they have. Going after the Houthis puts in the United States in a kind of proxy war with their backers in Iran, raising concerns about a slippery slope that could bring the two powers into more direct conflict.

Yet Biden obviously felt he had no choice but to answer the Houthis’ aggression, and economics may be as much of a reason as anything.

The Houthi attacks on shipping were starting to get investors’ attention because they were pushing up shipping rates, potentially raising costs just as inflation is finally receding.

“The crisis in the Red Sea is putting increasing pressure on the global economy,” Fundstrat Global Advisors wrote to clients on Jan. 12. “A prolonged closure of the [Red Sea] could back up global supply chains and drive up the prices of manufactured goods at a crucial moment in the battle against inflation.”

Just before the US retaliation, the World Bank warned that the Houthi attacks “have already started to disrupt key shipping routes, eroding slack in supply networks and increasing the likelihood of inflationary bottlenecks …. Energy supplies could also be substantially disrupted, leading to a spike in energy prices.”

Big shippers such as Maersk and Hapag-Lloyd have begun taking costlier alternate routes, with more than 2,000 ships that would normally pass through the area finding another way. S&P Global Commodity Insights reports that shipping costs for containers affected by the detours have soared by 600% since Israel invaded Gaza and the Houthis started shooting.

These sorts of warnings are a red alert in the Biden White House, given that inflation has been Biden’s Public Enemy No. 1. Biden’s approval rating sank as inflation rose in 2022 and 2023, settling at a very weak 40% or so. There’s been good news on inflation, with the annualized rate of price hikes falling from a peak of 8.9% in 2022 to just 3.4% in the latest reading for December. Most economists think inflation will continue to drop and be comfortably back in the normal zone within 12 to 18 months.

But Biden can’t take any chances.

His approval rating has failed to recover as inflation has come down, and some polls show Biden losing to his likely Republican opponent, Donald Trump, in the 2024 general election. The Biden administration has been aggressively looking for ways to coax more oil on to global markets to help lower gasoline and energy costs. And they’ve [silently] applauded as US energy production has hit new record highs, knowing it will help keep drivers from revolting over high gas prices.

Biden is pulling every other lever he can to get prices down, touting, for instance, his plans to lower drug and healthcare costs and promote affordable housing. There’s not all that much any president can do to control inflation, which in the recent case is largely due to COVID-era distortions in supply chains and spending patterns. The economy itself needs to adjust, with help from Federal Reserve interest rate hikes that tamp down demand. Yet Biden is clearly willing to lend a hand where he can.

The Houthi strikes could backfire. Oil prices rose by about 1% on news of the strikes over concerns that a wider war could disrupt oil flows. The big question for markets is what happens next. Some analysts think Western strikes on the Houthis could be counterproductive, raising the profile of a rebel group desperate for attention and creating further pretexts for Iran-backed terror attacks on Israel and its allies. The nightmare scenario would be direct action by Iran that prompts retaliation, which could throw energy markets into disarray, something Biden and Tehran probably both want to avoid.

On the other hand, decisive US-UK military action may put an end to the Houthi attacks, no matter how loudly the Houthis condemn the West and promise further mayhem. Shippers that have been avoiding the region will be the first to decide if it’s safe to go back in the water. If things settle down, shipping rates will drop and another inflation scare will subside.

It’s a good bet, however, that there will be other scares.

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