Contract rate decline puts capacity at risk

Chart of the Week: National Truckload Index Linehaul Only, Outbound Tender Rejection Index – USA SONAR: NTIL12.USA, VCRPM1.USA

The relationship between dry van truckload contract (VCRPM1) and spot (NTIL12) rates remains nearly unchanged compared to last June, as both have fallen at nearly the same pace over the past 12 months. 

Spot rates appear to have hit a floor this summer, suggesting carriers have hit their park or drive threshold on the transactional market for now with contract rates continuing to drop. If the spread between these two figures narrows — even as demand falls — capacity will become increasingly inconsistent to secure. 

The domestic truckload market has been in freefall since last March with spot rates reacting first and the slower contracts — typically negotiated on three- to 12-month terms — starting a slow slide in late summer. The reason is simple: Demand fell off a cliff after shippers stopped their “just-in-case” over-ordering strategy brought on by an unreliable supply chain environment during the pandemic.   

The end result is after nearly two years of overheated and unsustainable demand growth, capacity has also increased significantly. The problem now is that demand has retreated almost entirely to where it was in 2019, leaving many trucks with nothing to move and a spot market full of desperation. 

It’s a buyer’s market

In June of 2019 the spot rate excluding fuel costs above $1.20 per gallon — comparable to a contract rate less a standard fuel surcharge — was offering about an 8% discount. The 2019 market was also fairly loose with abundant capacity. Currently the spot market is moving at a ~23% discount. 

The national Outbound Tender Reject Index (OTRI) measures the rate that carriers reject contract load coverage requests from their customers. The pandemic years of 2020-21 averaged above 20% — 1 in 5 loads rejected — while 2019 averaged around 6% — 1 in ~16. The average OTRI value so far in 2023 is 3.5% — 1 in 28.

With spot rates moving at such a strong historical discount, carriers are incented to cover everything they can under the more lucrative contract rates — keeping OTRI low. An OTRI value below 5% is indicative of a market in which carriers are in strong competition for business, pushing contract rates lower.

Combine the low rejection rate with the spot market discount and this means contract rates still have a long way to fall unless capacity exits the market significantly or demand spikes. 

How fast will rates fall?

For this forecasting exercise let’s assume spot rates will not fall significantly over the next six months, but they will likely spike around Christmas as they did this past year, despite the soft environment. 

Contract rates have fallen in nearly a perfect linear regression over the past year, so applying the same trend is not a risky assumption. There is an argument to be made that some acceleration in decline is due, thanks to the fact that many shippers’ transportation budgets will take a hit in the next year and many of the current rates were put in place before anyone realized the market had turned. 

Assuming a flat spot rate trend and continuing the current rate of decline for contracts, the spread will drop below 10% around the holiday season. This could make for a rude awakening for many shippers that have had an extended period of easy sourcing.

As carriers see spot load offerings improve in relation to their contract freight, they will be tempted to divert capacity to cover potentially more lucrative offerings, especially considering many of them have been struggling for over a year. 

Spot rates tend to jump around Thanksgiving and Christmas as retailers recognize what goods are most in demand. Companies are willing to spend more on transportation to ensure sales are not hindered by lack of inventory. The smaller window of opportunity also means increased service expectations — another inflationary force.

While this is not expected to be anywhere near the disruption in 2020-21, it could catch a few companies off guard during a critical period of time in a slowing goods economy. Many retail companies were able to mask the supply chain issues during the pandemic due to sales growth. With demand in decline, inventory shortfalls will possibly hurt more in 2023 than they did then.   

About the Chart of the Week

The FreightWaves Chart of the Week is a chart selection from SONAR that provides an interesting data point to describe the state of the freight markets. A chart is chosen from thousands of potential charts on SONAR to help participants visualize the freight market in real time. Each week a Market Expert will post a chart, along with commentary, live on the front page. After that, the Chart of the Week will be archived on FreightWaves.com for future reference.

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Source: freightwaves - Contract rate decline puts capacity at risk
Editor: Zach Strickland, FW Market Expert & Market Analyst