If a flattening of the yield curve or a falling credit impulse haven’t got you spooked about the prospect of a recession yet, the surge in the oil price might. Because every single time since the ‘70s that the inflation-adjusted oil price has deviated from its overall trend by 50% or more, a recession has followed. And it’s just done exactly that.
There’s a few reasons why the two seem to be linked. First, surging oil prices mean higher prices at the pump, directly eating into consumers' budgets and reducing the amount of money they have to spend on other goods and services. That directly impacts economic growth.
Second, oil is a key component in pretty much everything, from the aspirin you take to cure your hangover to your favorite running shoes. So when its price rises, the prices of all those products do too (plus it gets a lot more expensive to transport them). That tends to exacerbate inflationary pressures, which in turn leads to lower purchasing power for consumers and lower margins for companies. And when their margins shrink, companies cut costs, which means lay-offs and even more pressure on consumer budgets.
Third, a high oil price makes it more difficult for central banks to soften the blow to economic growth by lowering interest rates. And if they have to raise rates when growth is slowing, company valuations tend to shrink and investors become more risk-averse. That leads to less investment and lower growth, and the vicious cycle goes on…
And sure, maybe this time’s different. But unless you’re absolutely certain of it, you might be better off accounting for a higher probability of recession and preparing your portfolio for tougher times ahead.
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