A week ago, we reported that the rise in oil and gas prices caused by the conflict in Ukraine had increased the threat of worst stagflationary shock hitting Europe since the 1970s. Europe is at serious risk of plunging into a deep recession if Russia follows through on its threat to cut off gas supplies. The United States seems to be on safer ground thanks to its much lower reliance on Russian energy commodities. After all, only 1% of the oil consumed in the country comes from Russia.
But that alone shouldn’t lull the world’s largest economy into a false sense of security.
With markets teeming with bearish economic signals, a cross section of pundits have warned that the US economy could be hurtling towards a recession. Skyrocketing energy and commodity prices, hyperinflation, rapidly flattening yield curves and a slowing economy are signals that all is not well.
But Wall Street is now more concerned about a more fleeting but powerful red flag: the negative correlation between oil stocks and the broader US stock market.
The correlation between S&P 500 Energy Index and the widest S&P500 turned negative for the first time since 2001, thanks to a combination of rising oil prices and a sell-off in the technology sector. The S&P 500 has returned -6% year-to-date, a far cry from the energy index, up 39% year-to-date. the Information Technology Index fared even worse, down 10% over the period.
Analysts are now warning that such divergences have historically preceded recessions.
Founder of Commodity Context Rory Johnson told Bloomberg that the last time the correlation between oil and gas stocks and the broader market was so important was the bursting of the Dotcom bubble.
“With oil prices as high as they have been, this is going to be positive for energy stocks and negative for the rest of the overall economy,” Johnson said.
According to Johnston, the divergence between energy and the broader market has widened since the start of the year, but “has moved up a gearsince Russia invaded Ukraine in late February and sent oil prices above $100 a barrel while introducing new geopolitical risk to the stock market.
Related: US Energy Tycoons See Net Worth Jump 10% Since Ukraine War Started
Like most long-term trends, the normally positive correlation between the energy sector and the broader market is likely to mean revert. However, analysts warn that there will be no soft landing.
“For energy prices to fall significantly, we could speak of a recession-like situation, in which case the S&P 500 would also fall significantly and, therefore, the correlation would return to positive territory.Stifel Nicolaus analyst James Hodgins told Bloomberg.
Great Inflation 2.0?
Since the correlation between energy stocks and the rest of the stock market tends to stay positive in good and bad business cycles, it’s not a very reliable indicator of the state of the economy.
Wall Street has come up with other criteria – and the yield curve is a favorite.
The yield curve is the difference (or “spread”) between short-term and long-term government bond yields. An inverted yield curve, where short-term bonds yield more than long-term bonds, has correctly predicted every recession since 1955, with only one false signal in nearly 70 years.
And a flashing red warning sign appeared: Wednesday, the gap between two- and ten-year US government bond yields reduced to just 0.2%.
Even assuming the yield curve gives another false red flag, meaning we’re not on the verge of a recession, the alternative isn’t very encouraging either. Because the one time an inverted yield curve didn’t lead to a recession, it beckoned something just as bad: the “Great Inflationwhich ran from the mid-1960s to the early 1980s.
The level of inflation in the United States has now reached 7.9%, a level last seen in 1982, around the end of the last great inflation. But it could get even worse: traders are now setting their prices in a The US inflation rate is heading towards 8.6% in March and Aprill before Federal Reserve officials even had a chance to offer a possible 50 basis point interest rate hike in May.
The Fed last week made its first rate hike in four yearsincreasing the federal funds rate by 25 basis points.
“Unfortunately, this may have been the time when the market and society needed a shock and admiration showing that the Fed is still very focused on controlling inflation. Raise rates 25 bps basis, without quantitative tightening, has almost added fuel to the fire. Main Street says, “We can raise prices any way we want, regardless of competition. So far, that’s true,Gang Hu, a TIPS trader at New York-based hedge fund WinShore Capital Partners, told MarketWatch.
That said, several critical recession signals remain in the green.
First, industrial production, a key indicator of economic strength, rose 0.5% in February to a level 103.6% higher than the 2017 average and 7.5% higher than that. that it was at the same time last year.
the US Purchasing Managers Index (PMI), which tracks the sentiment of buyers working for manufacturing and construction companies, came in at 57.3 last month, more than 6% higher than the US average over the past decade. .
Meanwhile, the United States economic policy uncertainty indexwhich measures political concerns, also fell to 139 in February from more than 200 in December 2021, indicating that fears surrounding a political mishap by the Federal Reserve or the Biden administration are fading fast.
Perhaps the outcome of the Ukraine crisis will be the straw that will break the camel’s back and plunge the US economy into full recession or back into recovery mode.
By Alex Kimani for Oilprice.com
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