US RECESSIONS AND THE OIL PRICE 1970 – 2024
The oil price has rallied 22% over the past four months, since it bottomed at $74/bbl.
Slowly but surely, traders are being forced to realise that “geopolitics, energy price developments and demographics” are critical for the global economy, as European Central Bank president Christine Lagarde noted 2 years ago.
History never repeats itself – but it does rhyme. And there are increasingly strong echoes today of the chaos that engulfed the global economy in the 1970s:
- Cold War tensions were then a fact of life, with the Berlin Wall physically splitting the West and the Soviet Union
- Western support for Israel in the Yom Kippur war led to the October 1973 – March 1974 Arab OPEC countries (OAPEC) oil embargo
Today, of course, we have a real war underway in Ukraine. And Russia’s leader, President Putin, continues to threaten the West with nuclear war:
“They should eventually realise that we also have weapons that can hit targets on their territory. Everything that the West comes up with creates the real threat of a conflict with the use of nuclear weapons, and thus the destruction of civilisation.”
Plus Russia is now a member of OPEC+, and is using the “oil weapon” to push oil prices higher.
OPEC+ confirmed its new output cuts on Wednesday, just ahead of the important summer driving season in the US.
FINANCIAL MARKETS STILL WANT TO BELIEVE IN CENTRAL BANKS
S&P 500 v US 10-YEAR INTEREST % 2009 – 2024
Financial markets have been slow to realise that geopolitics are once again starting to replace economics as being key to decision-making. They still want to believe that a US Federal Reserve Board of 12 men and women in Washington can somehow control a global economy of 8bn people.
But in reality, as the chart shows, the key US 10-year interest rate bottomed 4 years ago at 0.6%. And since then, it has risen 7x to >4.2%.
There is little to suggest that rates will return to previous stimulus lows. Instead, rising levels of risk around the global economy suggest that investors may soon need to focus on Return of Capital rather than Return on Capital.
OPEC+’s MOVE TO INCREASE QUOTAS IS SET TO PUSH INFLATION HIGHER
Essentially, we are therefore moving into a world where ‘Business as Usual’ means adjusting to continuous instability:
- As the chart suggests, we are already seeing military spend start to increase
- Trade wars are developing, as Western governments need to preserve key industries
This instability creates an additional challenge, as it means things are not always what they seem:
- For example, buyers are intelligent enough to know that oil prices are a key driver for inflation. This may be direct, for products made from oil – or indirect, as higher oil prices impact the wider landscape.
- So, this uncertainty leads to the phenomenon of “apparent demand”. When buyers see oil prices start to rise, they don’t wait for higher prices to impact. They buy forward to protect margins.
In turn, employers hire more staff to cope with the expected rise in future orders. And so US employment numbers will appear strong, and interest rates will rise – as happened on Friday.
But at the same time, higher prices are actually reducing demand in the real world:
- Consumers only have a limited amount of money to spend
- If oil prices are low, consumers can spend more on the discretionary items that boost global GDP
- But if oil prices are high, they cut back in order to afford the essential cost of gasoline and heating/cooling their home
This impact was hidden during the stimulus period, when central banks and governments handed out vast amounts of free cash. But those days are now over.
And so a new generation is starting to learn the painful lesson that high oil prices, at >3% of global GDP, will in time have a very negative impact on demand and global growth.