- Tags : Macroeconomic Update
By: ProcurementIQ Analysts, Braden Baseley & Torsten Edstam
Each quarter, ProcurementIQ prepares an update that identifies the most significant recent macroeconomic trends affecting procurement professionals. ProcurementIQ's updates are intended to help these professionals better understand the broader purchasing environment and make strategic buying decisions. This quarter, ProcurementIQ’s update is focusing on commodity prices, trade issues and government policies that can substantially impact business purchases.
The Variable Nature of Commodity Prices
In the three years to 2017, prices for copper, aluminum and steel have been falling. Manufacturers have benefited from lower productions costs as the prices of these metals have declined and placed downward pressure on prices for goods like electrical wire and industrial welded carbon steel pipes. Although prices for copper and aluminum are forecast to rebound in the next three years, steel prices are projected to continue falling 3.4% on average per year until 2020 due to oversupply and weak demand. Fortunately for buyers, market prices for products that are reliant on steel are expected to soften.
In addition, the world price of crude oil has been falling in the three years to 2017 as a result of overproduction and the United States lifting its 40-year ban on oil exports. Falling crude oil prices have led to reductions in the price of fuels, like gasoline and diesel fuel, and lowered operating expenses for downstream markets that rely on this commodity, such as national trucking services. Although crude oil prices have been falling in recent years, OPEC agreed to slash oil production in 2017, which has caused oil prices to rebound somewhat. This trend is projected to continue through 2020, with ProcurementIQ forecasting that the world price of crude oil will grow at an annualized rate of 3.3%. To hedge against growing commodity prices, businesses can lock in lower rates now, source alternatives or buy in bulk to attain cost savings.
- Copper and aluminum prices are projected to rebound during the three years to 2020, which can make products manufactured from these materials more expensive for businesses to purchase. However, the price of steel is forecast to continue declining due to overproduction.
- Crude oil prices have been declining during the past three years but are expected to recover due to OPEC cutting production, which will result in higher costs for businesses.
- Businesses can enter into long-term supply agreements, shift to alternatives or buy goods in bulk to hedge against fluctuations in commodity prices.
Hammering Out a Trade Deal
In addition to fluctuations in commodity prices, changes in the trade environment also impact procurement markets. The United State currently runs a trade deficit, meaning that imports exceed exports. The most common imports, which primarily come from China, Mexico and Canada, include automobiles, oil and gas, computers, pharmaceuticals and semiconductors. The presence of imports fosters competition in many of these marketplaces, as domestic operators reduce prices to compete with foreign providers. Consequently, an increase in imports frequently causes slower price growth or even falling prices. However, buyers must often contend with additional shipping costs or tariffs, raising the total cost of ownership for these products.
One of the key trade policies that regulates tariffs on imported goods is the North American Free Trade Agreement (NAFTA). Since 1993, NAFTA has eliminated tariffs between the United States, Mexico and Canada for a variety of products, including agricultural goods, automobiles and textiles. As a result of NAFTA, US manufacturers and other businesses now depend heavily on imported intermediate and finished goods from Mexico and Canada. Total trade between the United States, Mexico and Canada has soared since its inception, reaching a value of $1.1 trillion in 2016.
Despite the value of NAFTA for many US businesses, the Trump administration has threatened to withdraw the United States from the agreement and began renegotiating it in August. The exact terms of the renegotiation are still being considered; however, there is a risk that tariffs could increase on some goods currently imported from trade partners duty-free. If tariffs on these goods do increase, then suppliers could pass the heightened cost on to customers. Unfortunately for US businesses, markets that involve both intermediate goods, such as synthetic fibers and catalytic converters, as well as finished goods, like uniforms, truck trailers and semi trucks, may potentially be impacted negatively by the renegotiation due to rising prices. Fortunately, however, it will likely be a year before businesses begin feeling the effects of the renegotiation, which gives procurement professionals time to plan by making strategic purchases. For example, businesses can take advantage of lower prices now or begin sourcing substitute goods. By making these decisions, procurement professionals can prepare for a smooth transition as the terms of NAFTA are renegotiated.
- Imports encourage competition in domestic markets, which helps keep prices low for businesses.
- Imports may result in additional costs for businesses, such as shipping and tariffs, as well as longer lead times.
- The Trump administration is renegotiating NAFTA, which could lead to new tariffs and cause the prices that buyers pay for imported products to rise.
- Businesses can prepare for potential changes in trade policy by taking advantage of lower prices now or procuring substitute goods.
Rewriting the Rules
The NAFTA renegotiation is part of the larger story of the Trump administration’s efforts to reduce the US trade deficit by restricting imports. It goes hand in hand with the cancellation of the Trans-Pacific Partnership and other policy changes, including the Buy American, Hire American executive order, which President Trump signed in April. The order is intended to curb the detrimental effects of increasing globalization on US workers. It tightens standards for federal procurement departments by directing all agencies to buy domestically produced materials for daily operations and government-funded projects. Additionally, the order introduces new restrictions on H1-B work visas, making it more burdensome to hire foreign workers.
The order could have a major impact on government procurement officers because it narrows the selection of potential suppliers and exacerbates work shortages in competitive markets. A sudden increase in demand — for example, from a large infrastructure spending bill — in combination with a smaller supplier pool could cause price spikes for construction materials, including nonelectric iron and steel wire and sheet metal. Moreover, common manufactured goods that have been falling in price during the past three years due to rising imports, such as laptop computers, desktop computers and other IT hardware, could reverse trend and undergo price growth. Finally, there is also the H1-B visa issue. By restricting these visas, the order may also affect wage costs for certain markets, particularly in the IT sector, which depends heavily on foreign labor. IT systems integration, software development and network planning and design could all increase in price as H1-B visas are restricted. Although it is still too early to see the full effects of the order, procurement professionals can make strategic purchasing decisions by leveraging a variety of market characteristics, like strong domestic competition or the easy availability of substitutes, to negotiate for lower prices.
Other recent policy changes may also have an effect on procurement. In June, the Federal Open Markets Committee set the current target of the federal funds rate at 1.00% to 1.25%. This increase in rates could potentially make business financing more expensive. However, that same month, the House of Representatives passed the Financial CHOICE Act, which would deregulate the financial sector by eliminating key provisions of the Dodd-Frank Act (2010). Dodd-Frank increased federal oversight over the conduct of financial institutions, like commercial banks, resulting in tens of billions of dollars in compliance costs for these companies. Although the Senate is likely to put forth its own reformulation of Dodd-Frank, deregulation would absolve financial institutions of many of these compliance costs. As a result, the cost of financial services, like commercial lending services, could fall at the expense of consumer protections. Ultimately, because it remains unclear how these policy changes will be implemented, businesses that expect to need financing may benefit from locking in rates sooner rather than later.
- The Trump administration issued the Buy American, Hire American executive order in April, which may cause prices to rise for certain products and services.
- Although the order may lead to price increases in some markets, businesses can leverage different market characteristics, such as strong domestic competition, during negotiations.
- Deregulation of the financial sector, which Congress initiated with the Financial CHOICE Act in June, may lower compliance costs for institutions like banks and insurers, which could result in cost savings for their customers.