Are we about to witness a U.S. recession?

Could the prices of oil be pointing to a U.S. recession? 

Just last week I discussed how important oil prices are to the market, and now it seems it is more important than ever. 

As stated in the previous blog oil makes the world go round. Even with the rise of renewable energy, oil is still the most consumed primary energy fuel in the world. 

Demand for fossil fuels has also remained high, with the use of oil consistently growing each year. 

The United States is the world’s largest producer of oil. Having held that claim for the past six years, with an average production of 19 million barrels per day in 2023. Other top producers include Saudi Arabia, Russia, Canada, Iraq and China. 

So it’s fair to say that oil price fluctuations play a critical role in the stability of top economies in the world. 

As of writing this oil prices have traded through the key support lows of $65.00 per barrel, and are down 7% on the day. 

_{That’s the largest drop in a single day since Covid-19 hit the markets.} 

I wanted to use this opportunity to discuss how oil markets have influenced global recessions in history.

To understand this, we need to examine two scenarios where sharp changes in oil can create an ugly picture. 

First, higher oil prices.

Higher oil prices can lead to increased global costs, and in turn lead to reduced spending.

Breaking this down, when oil prices rise sharply, businesses' production costs also increase. These businesses then pass the costs on to the consumer, which impacts inflation in a negative way. When inflation rises it erodes the purchasing power of consumers, leading to reduced consumer spending and lower economic growth. 

The second scenario forms when oil prices crash.

When the price of oil crashes, it can impact oil producing regions and countries leading to lower government spending and stimulus, leading to job losses as global downturns. 

This scenario is playing out currently, oil prices are crashing as economic growth concerns climb. Remember the prices of goods and services have climbed significantly in the U.S. from 2016. Although the headlines show inflation rates month on month falling, showing a slowing of inflation doesn’t necessarily mean consumers have caught up, it means demand is slowing in the markets.

It is important to note that more recessions have come from oil prices rising rapidly than falling, but that being said there’s a couple in recent years that we can draw upon.

Oil price crash 2014- 2016

In 2014 and early 2016, oil prices collapsed over $100 per barrel to under $30 per barrel. 

The primary cause of this came from the U.S. Oil production in the states rapidly increased due to advancements in technology. Hydraulic fracturing also known as fracking allowed the U.S to become the world’s largest producer almost overnight. The oil supply to the global markets saw a massive increase, and as we know, more oil being produced, the lower the price. 

At the time many thought OPEC would react by cutting production to stablise the price, however that wasn’t to be the case. Instead OPEC tried to protect its market share by forcing U.S producers out of business as they had higher production costs. 

This ultimately led to the prices of oil falling, but it didn’t stop there. Slower economic growth in China and other countries led to a reduction in consumption. So the market was overproducing oil driving prices even lower. 

Sounds familiar right? 

This had large impacts on both oil exporters and importers. 

Oil exporting countries such as Venezuela and Russia faced economic problems due to the weakening demand. Due to the higher production costs in the U.S most oil companies went bankrupt, leading to huge job losses in the industry. 

For consumers it was great, lower oil prices at the pumps meant they had more money in their back pockets. Industries dependent on oil such as airlines saw a rapid reduction in operating costs, seeing demand for travel soar. 

Oil prices did end up consolidating and rising as OPEC and non-OPEC producers agreed to cut production. 

Oil Price Crash 2020

Ok this one is the one that’s still fresh in our minds. I mean oil prices at one point went negative which was just completely unheard of before this time. Covid-19 brought the world to a halt, with global lockdowns coming into effect, the need for oil just stopped. 

Again, OPEC and non-OPEC producers failed to come to an agreement on production cuts, meaning there was an unnecessary amount of oil flooding the market causing the prices to crash. 

Like with the previous example, we saw huge amounts of jobs losses across the industry and many oil companies filed for bankruptcy. This caused global market shockwaves, bringing short and sharp recessions across the globe. 

Consumers again were the ones to benefit in this moment as oil prices collapsed, but with the lockdowns being put into effect, demand still remained very low. 

What’s happening now?

We need to think about this scenario or narrative we have now.

• OPEC have decided to increase production 3 times faster than they’d previously planned. Reports are highlighting that OPEC, who are led by Saudi Arabia, have grown frustrated with other producers such as Kazakhstan and Iraq, as they are producing more, and want to show them how higher production impacts oil prices, and their wallets.

• Donald Trump has made it very clear that he wants oil prices lower in order to bring inflation down, and to get the Federal Reserve to cut interest rates. 

• Demand in general is down, this will compound the need for oil by businesses and in turn bring oil prices lower. 

Now, like all the other scenarios, we often see some sort of stubbornness between OPEC and non-OPEC producers which seems to lead to an oil price crisis, which leads to global recessions. 

Is this time looking any different? I’m not so sure.  

As traders how can we use this information?

When oil prices fall, it’s bad for producers, good for importers. 

I can’t believe I am bringing this up again, but it makes USD/JPY a great forex pair to watch. Why? Because Japan imports nearly all of their energy and if it costs less to do so, well it’s good for businesses. As we know, if oil prices fall it can have a negative impact on the USD. 

USD/JPY just makes sense yet again. Or at least the buying of Japanese Yen does. 

At the moment it looks like this market narrative will remain.