When they’re working well, global supply chains are largely out of sight and mind.

For years, we took for granted the complex network of relationships that saw raw materials shifted, transformed into finished goods and then distributed to consumers. 

But those carefree days are behind us – at least for now – and we are having to navigate an unfamiliar world of snarl-ups, delays and frustration.

Offshore parking lots jammed with container ships, a shrinking selection of goods for consumers and rising prices have been among the all-too-visible results.

Much of the current disruption originated with the arrival  of the COVID pandemic in 2020.

Increased demand for goods over services, a succession of disruptive virus variants, worker shortages and commodity shocks were among the forces that caused  supply chain gridlock.

For a time, it appeared as if things might be poised to improve this year.

With more than half the year gone, however, hopes for a quick recovery have been dashed.

A succession of factors have deepened the supply chain snarl-up — with China’s tough COVID containment efforts and Russia’s invasion of Ukraine presenting further challenges.

While the full implications of the Ukraine conflict for supply chains are not yet apparent, what is clear is that we are in a significant new chapter in the supply chain saga.

And that chapter has a distinct theme: supply chain pressures have proved to be more persistent and deep-rooted than expected even a few months ago.

These new pressures have shattered any hopes of an imminent healing in global supply chains.

Indeed, as long as the Ukraine conflict persists, it is difficult to envision any meaningful improvement in overall supply conditions.

How did we get here?

Let’s recap on how we got here.

As a new Citi Global Perspectives & Solutions (GPS) report on global supply chains notes, building on an earlier report in December 2021, there have been at least  five drivers.

First, increased supply chain complexity has seen stresses ripple out from trade routes between China and the US to trade ties between Russia and Ukraine and, ultimately, all of Europe.

That has come on top of a decades-long shift towards just-in-time inventory management.  

Yet the just-in-time practices that predominated before the pandemic left the system vulnerable to a set of shocks that had previously been discounted or not fully considered.

Companies had scoured the globe to find the cheapest and most flexible suppliers.

This approach worked well as long as transactions across borders were reliable and efficient.

But a succession of shocks — former US President Trump’s trade war, the pandemic, surging commodity prices, and now the Russia-Ukraine conflict — have increasingly undermined the system.

Second, the pandemic brought about a massive rebalancing in consumption towards goods and away from services, leading to pressure on global production chains. Services spending has now climbed back to pre-pandemic levels, but still looks weak compared with spending on goods.

Third, we had monetary stimulus — lots of it. This supported spending through the worst of the downturn, reinforcing the strength of goods spending and, in turn, amplifying pressures on supply chains. This situation has now shifted, however, as the macro stimulus that was put in place during the pandemic has generally been removed, or is in the process of being removed, in various economies.

Fourth, the pandemic has continued to evolve with new variants emerging. Although households, businesses and the public sector have generally become more adept at managing the challenges of the pandemic, a full recovery from its economic effects will require substantial further progress in managing the pandemic and reducing case counts.  

Finally, worker shortages have hampered a ramp up in production capacity.

Notably, the unemployment rate in major economies is now back down to readings roughly similar to those before the pandemic, and labor market pressures are emerging in a range of countries.

This shortage remains acute in the transportation sector, even as employment in truck transportation has now moved slightly above its pre-pandemic peak.

To gauge the ongoing tightness of supply chain conditions, Citi Research has developed the Citi Global Supply Chain Pressure Index.

This looks at a range of data that capture conditions in global shipping and logistics, inventories, and the performance of global purchasing managers’ indexes (PMIs) or purchasing manager indices, in particular production backlogs and supplier delivery times.

In spite of retreating slightly from its peak last autumn, the index continues to signal remarkable tensions in global supply chains, making clear that the stresses of 2021 are still very much present. The three underlying components of the global index — transport costs, PMIs, and inventory pressures — have each shown a distinct trajectory of late. Notably, the transport cost component has moved up in recent months, while inventories look to have essentially moved sideways. Global purchasing managers indices eased somewhat in December 2021 and January 2022, but then rose in subsequent months.

The unavoidable conclusion is that the factors that were driving supply chain pressure last year are very much still with us.

The Ukraine effect

Worse, Russia’s invasion of Ukraine has unleashed new pressures that have shattered any hopes of an imminent healing in global supply chains. In fact, as long as the conflict persists, it’s difficult to envision any meaningful improvement in overall supply conditions.

When the conflict erupted in February, global markets initially framed things as a shock to energy supplies. But the risks and pressures on supply chains extend well beyond energy. 

For example, Ukraine is a significant exporter of neon gas, which is used to make semiconductors.

Big manufacturers may have enough inventory to buffer the shock, but the picture for smaller producers is less clear. Ukraine also is an important producer of automobile cables, in particular wire harnesses. With exports of these cables disrupted, auto production in Germany has been hit.

Russia and Ukraine are also the largest exporters of wheat, processed nickel, and fertilizers; the second largest exporters of lumber, refined copper, steel, ammonia, and titanium; and the third largest for aluminum, coal, and gas turbines. With shipments from the region of such key products limited or under stress, the possibility of meaningful supply disruptions in the months ahead seems high.

The lessons companies can now learn

The supply chain management practices that prevailed in the years before the pandemic were based on two assumptions.

The first was that global supply chain structures — particularly shipping and logistics — were robust, cost-effective, and reliable. The second was that demand for goods would be relatively smooth and predictable.

Clearly, the system was not designed for the challenges that the pandemic threw up — let alone the Ukraine conflict.

Lockdowns resulted in shortages of key manufactured inputs and then, as producers struggled to catch up, created excess demand for shipping and transport services. The result has been unpredictable delivery schedules, as well as sharply higher prices for shipped goods.

The past two years have also seen surging demand for final goods coupled with episodic disruptions in the availability of the inputs required to produce those goods. In many cases, companies have accumulated some, but not all, of the inputs needed to produce. There are plenty of anecdotal stories of goods awaiting that final essential component to be installed before production can be completed.

The authors of the Citi GPS report believe that, as a result of this, companies are likely to respond in various ways. These include embracing digitization and electronic tracking of inventory and logistics; emphasizing partnerships with suppliers and long-term alliances; and changing inventory management to allow the holding of larger buffers, especially for critical components.

When it comes to inventory management, the largest companies have already started making clear they intend to re-examine the structure of their supply chains.

Previously, they had monitored front-line suppliers – that is, those supplying directly to them. But now, companies are increasingly focused on second- and even third-tier linkages — that is, their suppliers’ suppliers.

This should make manufacturing supply chains more resilient, while giving companies greater visibility into the challenges and risks — as well as the opportunities and potential efficiencies — that their supply chains provide.

There are several implications here.

First, as companies invest in knowing more about their second- and third-tier suppliers, we will start to see longer-term commitments baked into those relationships based on an expectation of reliable performance through the cycle, rather than just short-term cost considerations.

This should in turn have the effect of supporting the pursuit of sustainability objectives, especially companies’ efforts to understand the totality of their carbon footprint. It also may be a time to consider solutions that support financing of deep-tier suppliers or reward governance-focused suppliers.

Companies are also likely to continue to take steps to digitize and automate their supply chain and inventory management systems, in order to better incorporate information into business decisions.

What does the future landscape look like?

Perhaps the biggest effect of the new reality described above will be on the geographical contours of supply chains, and how they may shift.

The big takeaway for many companies has been that far-flung supply chains carry previously uncontemplated risks. Given current geopolitical realities, this may be particularly true for US companies relying on suppliers in China. Indeed, there may be long-tail consequences resulting from the Ukraine conflict. For instance, the reconfiguration of global supply chains away from nations deemed to be unfriendly to the West could be accelerated.

The Citi GPS report’s authors anticipate that some US companies and possibly those from other countries, will seek to diversify their supply chains away from China. Some corporates more widely may also redouble efforts to move from a just-in-time to just-in-case model.

Citi Global Wealth Investments shares this view and believes that southeast Asian economies are among the leading potential beneficiaries – see our Rise of Asia theme.

Ultimately, it is also plausible that an increased share of production will be brought home — or re-shored — entirely.

In terms of the effect on specific sectors, there are some positives. Precious metals like palladium should be able to recover quickly as its shipment can be routed to China by air. It could take just one to two quarters to readjust this supply chain. However, it would be much harder to readjust bulk commodities like steel.

In the industrials sector, it is noticeable when looking back to past situations defined by both disruption and inflation, that the market tends to find a solution. If there are supply constraints on a certain component in the manufacturing process, new technologies that use less of these products come around. To offset disruptions, supply chains can also rebalance — they can reroute and choose to purchase from other regions. This can happen in the space of a few quarters for most areas.

In technology, the GPS report’s authors believe that by the end of 2022, supply and demand could come back into balance for some end applications like smartphones and personal computers. However, in the automotive supply chain, a balance in terms of supply and demand is unlikely to be achieved before 2023 at the earliest.

Amid the uncertainty, however, some things are clear. A prolonged period of volatility and unpredictability seems likely. Rising interest rates will also affect market dynamics. If geopolitical tensions remain, the reshaping of global supply chains will be a fluid affair.

This means that planning for every eventuality is impossible. But building greater resilience into supply chains is key – and banks can play a key role in helping to support companies as they embark on this task.

At Citi Global Wealth Investments, we believe that all of this has significant implications. Commodity shortages and price volatility have deepened the uncertainty facing investors in 2022. The potential for further dislocation – be it from the Russia-Ukraine conflict or elsewhere – remains significant.

Market forces may take two years or more to ease supply chain pressures, depending on the sector.

The Russia-Ukraine war has generated shortages in global commodities and further dislocations in supply chains.

Other producers will have to fill the gap. Investing to address this challenging situation may offer a portfolio hedge. Citi Global Wealth Investments explores how in Overcoming supply shortages.