A closely monitored oil market indicator is raising alarm bells for the American economy, sparking concerns that a significant economic downturn may be on the horizon. Market analysts have been buzzing all week about research indicating that when oil prices surge more than 50 percent above their long-term trend, a recession almost invariably follows.
Historical Record of Oil Spikes and Recessions
The indicator boasts a chilling track record: over the past half-century, there have been six instances of oil price spikes, each accompanied by a recession. Brent crude, the international oil benchmark, reached four-year highs above $110 per barrel midweek, driven by escalating turmoil surrounding Iran, the Strait of Hormuz, and ceasefire negotiations. Efforts to de-escalate the conflict helped lower prices heading into the weekend, but international crude still traded as high as $113 on Tuesday, comfortably exceeding the 50 percent threshold above its long-term trend.
“The longer oil prices remain elevated, the worse the trade-offs become, with softer growth and labor outcomes, and stickier inflation,” warned Christian Hoffmann, head of fixed income at Thornburg Investment Management.
Broader Economic Concerns
Oil prices are far from the only recession signal flashing today. Top economist Gary Shilling recently cautioned that almost nothing could prevent a US downturn later this year, and legendary hedge fund manager Ray Dalio stated that the US economy is already in troubled waters. However, surging crude oil poses the most immediate threat to the economy, prompting the Trump administration to work diligently to extricate the US from the Iran conflict and drive prices down.
The 1973 recession arrived after oil prices spiked due to an OPEC oil embargo, causing widespread fuel shortages across the United States. The question remains whether the damage has already been done and whether this surge will lead to a seventh accurate recession prediction for this indicator.
Economic Ripple Effects
When crude prices rise rapidly, the damage ripples throughout the economy, pushing up costs across the board. Gasoline, airfares, shipping, and food products—to name just a few key items—become more expensive, raising the cost of doing business for everyone. This also leaves households with less disposable income and presents the Federal Reserve with a difficult choice: cut interest rates to protect jobs or keep them high to prevent another flare-up in inflation.
Oil price shocks were the primary cause of multiple recessions in the 1970s, early 1980s, and early 1990s, all of which saw international crude prices 50 percent above their long-term trend. However, other recent downturns, including the 2001 recession and the global financial crisis, were not directly caused by sharp oil price increases. These later recessions may have been accompanied by oil price spikes, but the main driver was a bursting stock market bubble.
“The relationship between oil and the economy is less clear this time around because geopolitics are driving energy prices instead of normal economic cycles,” noted David Russell, global head of market strategy at TradeStation.
Current Economic Landscape
“Americans don’t like $5 gasoline, but they can afford it,” said Russell. “Adjusted for inflation, we are still well below 2008 levels.” Luca Paolini, chief strategist at Pictet Asset Management, first published the chart circulating this week back in 2022, when a huge crude oil price spike caused by Russia’s invasion of Ukraine threatened markets with recession. This time, Paolini indicated that international crude prices would need to stay higher for longer to trigger a downturn.
“Oil prices above $120 until the end of summer, which implies the Strait of Hormuz remains closed until then, would trigger a recession,” Paolini explained. Russell believes the world would likely have an oil glut without the Iran crisis and notes that while higher oil prices are slowing the global economy, they are not yet derailing the US economy, which remains strong due to massive spending on artificial intelligence.
In his recent recession call, Shilling focused on the immense pressures hurting consumer spending, which fuels roughly two-thirds of the US economy. He was particularly unsettled by energy prices rising 12.5 percent year-over-year in March, driven by the Iran conflict. Tracy Shuchart, senior economist at NinjaTrader, agrees with Shilling, noting that the poorest 20 percent of US households spend a vastly larger share of their income on gasoline and heating than the wealthiest Americans.
“Energy is a regressive cost,” Shuchart said. “Wage growth at the lower end does not keep pace with energy inflation, and the pass-through into food and goods—through diesel and fertilizer costs—hits poor households a second time.” This dynamic is precisely what McDonald's, Domino's Pizza, and Wingstop have been discussing in their recent earnings reports.
However, Shuchart points out that the US today has a very different economy than during earlier downturns foreshadowed by oil price spikes, as it has become the world's largest oil producer in addition to being the largest consumer. “There’s a lot of research from people smarter than me that has shown that right now, the number to watch is around $140 a barrel,” said Rob Spivey, director of research at analyst firm Altimetry.
