Further Oil Price Spikes Could Rekindle Recession Fears

Recent oil price spikes have reignited fears of a potential recession, marking the first time since the early days of the Iran war. Brent Crude prices surpassed $100 per barrel for the first time since July, and the U.S. benchmark WTI Crude also exceeded $100 a barrel due to escalating U.S.-Iran tensions with no resolution in sight.

For six months, global and U.S. economies endured the worst energy market disruption in history, with oil and LNG flows disrupted at the Strait of Hormuz. Countries released oil stocks from strategic reserves, China limited crude oil imports and fuel exports, and high oil and fuel prices helped maintain relative market stability.

However, these buffers have now disappeared. The United States now has the lowest crude stocks in its strategic reserve since the early 1980s, while China has eased restrictions on fuel exports and increased crude purchases, with imports recovering from a decade-low in June. But fuel supply remains severely limited, and the stress in fuel markets has intensified due to refineries outside the Middle East and Russia unable to compensate for the supply loss from these regions.

As a result, diesel and gasoline prices soared, with U.S. gasoline prices reaching a record high for this time of year, typically dropping due to lower seasonal demand. Diesel, the main fuel of the economy, has hit an all-time high average of $6 per gallon in the United States, surpassing the previous record of $5.85 last week. The spike in crude and fuel prices is driving up Treasury yields and longer-term borrowing costs, potentially prompting the Fed to raise its key interest rate as early as next week to counteract an anticipated inflation shock.

Goldman Sachs, an investment bank, estimates a 15% chance of recession within 12 months, down from a 30% probability in March, but warns that another shock could raise this risk again. Recession risks may be distant now, but a further spike in oil and fuel prices could increase the odds, according to Goldman Sachs Chief Economist Jan Hatzius.

The bank projects 1.5% GDP growth in the second half of the year, but this projection excludes another major shock. If gasoline prices remain high or spike further, economic growth and consumer spending would be adversely affected, as record-high diesel prices translate into higher prices of goods and accelerate inflation. This situation is particularly painful for Americans, especially during the holiday season when diesel prices traditionally rise, adding to the economic burden.