When analysts talk about the biggest threats to the second longest economic expansion in US history that has sent the unemployment rate in the US to its lowest level in 18 years, the risk of a trade war often occupies a sizable chunk of the conversation. And now that President Trump has decided to slap Section 232 tariffs on metals imports from some of America's closest allies, we'll be hearing even more about the risks as academics and economists latch on to the notion that tariffs will harm the US economy (the same way Brexit would unleash a UK depression).
But while trade-war related risks have yet to materialize, the possibility that we're headed for - or are already in the middle of - an oil shock is looking increasingly more likely, despite numerous analysts and economists writing off rising oil prices as a non-issue (in a recent note about how rising oil prices will impact the Asian economy, researchers at SocGen played down oil price risks to both growth and inflation).
However, those ignoring the very real problems posed by climbing crude prices at this point so very late in the business cycle do so at their own peril, as David Fickling, an opinion columnist at Bloomberg, pointed out in a recent column.
But it's not just big bank strategists who are overlooking the risks of rising oil: the abovementioned SocGen energy analysts see oil price pressures receding in the near future as OPEC and Russia start to crank up production, pushing the price of crude lower. As it turns out, retail investors are also overlooking the risks, too.
As evidence, Fickling points to the number of web searches for the terms "oil shock" and "oil crisis". Judging by this trend, an oil shock would seem to be "the last thing anyone should be worried about"
And yet, as Fickling points out, the number of warning signs suggesting that oil prices are already having a very real negative impact on growth - particularly in Asia and South America - are rapidly increasing.
- In Brazil, a strike by truckers protesting the price of fuel brought the economy to a halt over the past week, interrupting exports of soybeans, coffee and chicken and prompting some to call for a return to military dictatorship.
- In India, prices for diesel and gasoline have hit multi-year records, leading to demands for the government to cut taxes and for a price cap to be imposed on state-controlled Oil & Natural Gas Corp.
- Governments in Thailand, Vietnam and Indonesia and implementing or planning increases in retail fuel subsidies to protect consumers from the effects of rising oil prices and weakening national currencies.
- Airline profits have probably peaked because of headwinds from fuel costs, according to Alexandre de Juniac, CEO of the International Air Transport Association. Philippine budget carrier Cebu Air Inc. this week promised to impose fresh fuel surcharges.
- Moody’s Investors Service just blamed high oil prices in part for a 0.2 percentage-point cut in its outlook for India’s 2018 GDP growth, and warned of the potential of falling consumption spending and rising inflation across the globe if current high prices are sustained.
Meanwhile, as discussed on several prior occasions, the counterintuitive rise in the US dollar, and the tightening in financial conditions, that has accompanied the increase in oil prices has presented a double-bind for net oil importers in Asia and elsewhere outside the developed world - where investors are also coping with the inflationary shock of a depreciating currency. But the US economy is hardly immune. As a 2011 research paper written by James Hamilton at UCSD suggests, a spike in oil prices is an eerily prescient predictor of economic downturns - even if the increase isn't, relatively speaking, all that large relative to the recent past.
Take the first Gulf War. In the five months between Saddam Hussein’s 1990 invasion of Kuwait and the start of Operation Desert Storm, a spike drove West Texas Intermediate to an average $30.84 a barrel. Despite representing little more than a return to the status quo before Saudi Arabia flooded the market late in 1985, those prices were high enough to help spark the early 1990s recession.
As it turns out, "it's not the size of the oil shock, it's how fast you use it", or rather the speed at which it takes place. Hamilton's research shows that rapid jumps in oil prices have preceded 10 of the last 11 peaks in the US business cycle since World War II. The only exceptions were 1970, 1973 and 2003, which took place during - or just after - periods of recession.
By comparison, over the past 11 months, Brent is up 62% and WTI is up 46%. But how do we determine whether a move is sufficiently "rapid" to present a genuine shock? Hamilton's analysis involves comparing current prices to levels over the previous three years; this is what he finds:
Where prices are below their previous peak, any increase can be considered a return to the norm; where they’re above that level, there’s the possibility of a genuine shock. On a Hamilton-style measure, we’re seeing the strongest flashing red light since 2008.
In itself, that's an ominous signal but as Fickling notes, other signs of impending recession - the end result of any genuine shock - are looking more subdued. Still, Citi's global economic surprise index is at its lowest level in roughly five years for a reason...
Meanwhile, as we noted earlier SocGen analysts expect rising prices to have little impact on growth and inflation in Asia, a region that, due to its net-importer status (just 8% of global oil production is rooted in Asia), is often the hardest hit when prices climb, and particularly so when oil rises in tandem with USD. Their reasoning? Improving energy efficiency in China and elsewhere on the continent, combined with comfortably low inflation, suggest that a shock isn't imminent.
"Only if oil prices were to surge higher from here to $100 per barrel and sustain around that level for several quarters or more, would we start to worry," the team wrote.
But as Fickling counters, oil shocks are prophets - not partners - of economic downturns. This means that one shouldn't expect to see other signs of weakness until the shock has already taken root.
So unless supplies surge and prices ease sharply, and in the very near future to offset what has already been a remarkable "oil shock", the next downturn may already be a forgone conclusion.