This is why spiking oil prices and gas at $5 a gallon may not lead to a recession

Published Tue, Mar 8 202211:33 AM ESTUpdated Tue, Mar 8 202212:30 PM EST

Patti Domm @in/patti-domm-9224884/@pattidomm

Much higher oil and gasoline prices increase the chances for a recession, but economists say the U.S. economy is resilient and should dodge one for now. New growth fears emerged in markets this week as the U.S. moves toward sanctioning Russian oil . Already, investors worry Russia's invasion of Ukraine would boost inflation and weaken growth, creating a stagflationary environment. Russia has already had a difficult time unloading its seaborne oil, with its financial system being sanctioned by the U.S. and others for its invasion of Ukraine. Banks are concerned about financing Urals crude, and logistics companies and customers are worried about running afoul of sanctions. U.S. oil prices rocketed to as high as $130 per barrel as the week began on concerns all of Russia's energy would be sanctioned. West Texas International crude futures were at about $127 per barrel Tuesday. Last year, the U.S. imported about 670,000 barrels a day of Russian oil, or about 8% of its total oil imports. The imports had fallen off even before the Ukraine invasion. Europe is not participating in the sanctions, and it had been importing about 4.3 million barrels a day from Moscow, including 800,000 via pipeline, according to Goldman Sachs. U.S. consumers are already feeling the pinch. Unleaded gasoline prices gained sharply across the U.S in just a week, according to AAA. The national average for a gallon of unleaded gasoline jumped to a record $4.17, and analysts expect it to easily move to $5 and higher nationally. Bank of America economists note that "there is no clear off-ramp for Russia, hence our base case assumes many months of high uncertainty, tough sanctions and elevated energy prices." Russia's economy is expected to fall into a deep recession, and European growth should slow fairly dramatically. But the U.S. is only expected to see a modest impact on growth from higher energy costs, in part because of the momentum in the economy, a strengthening consumer base and because the U.S. is now a major energy producer. Oil may also come from other sources to make up for the loss in Russian energy. Iran is in talks to enter a new deal that would lift sanctions on its oil in exchange for ending its nuclear program. Even more risk for stocks The spike in oil and worries about stagflation have created an even riskier environment for investors. "For markets this means more dollar strength, some upward pressure on interest rates and ongoing downward pressure on risk assets," the Bank of America economists wrote. Evercore ISI's Julian Emanuel said he cut his S & P 500 target for the year this week to 4,800 from 5,100 . He expects there could be a bigger drop in stocks that could take the S & P to a technical level of 3,670. "The market has to price in an increased chance of recession. I think it's in the process of doing that and I think it's going to continue doing that," Emanuel said. Yet, Emanuel does not expect a recession, citing a strong economy that is rebounding as the pandemic recedes. Evercore still expects growth of 3% this year, down from a prior forecast of 4.5%. Emanuel expects value stocks to continue to perform better than growth, and notes that health care is an area that should provide safety, and it's cheaper than other sectors. No outright recession Economists say there should be a hit to economic growth but not an outright recession, unless the price of oil holds at high levels for a protracted time. The duration of the war and sanctions on Russia, as well as the ability of new supply to make it to market will decide what happens to the economy. Economists also note that unlike in the last real oil spikes, like the $147 per barrel high in 2008, the U.S. is now a very large producer of oil and gas. The U.S. entered a recession shortly after that oil spike. "I've got a recession if we really ran hot through the third quarter, above $120 a barrel. That with rate hikes, puts you into recession quickly," said Grant Thornton chief economist Diane Swonk. But Swonk added the economy is strong, and she expects oil prices to retreat later in the year. That should result in an economic hard landing and sluggish growth of just about 1% in the second half. Economists surveyed in the CNBC Rapid Update have a consensus forecast of 3.2% for 2022, a 0.3% decline from their February forecast. Bank of America economists Tuesday cut their growth forecast to 3.3% from 3.6%. They also lowered their forecast for 2023 to 1.9% from 2%. "The U.S. has become less sensitive to energy shocks in recent years. The share of income spent on energy commodities has dropped from mid-3% in the 1960s to the 1980s to just 2.1% in 2021," wrote Bank of America economists. "In addition, the shale revolution since the mid-2000s has made the U.S. 'energy independent' with net exports of petroleum products turning positive in 2019." Economists say the shift by the U.S. in the past 15 years to be a major oil producer and exporter, instead of just a major importer of energy has changed the way an oil shock should hit the broader economy. High oil prices used to mean more cash would flow from America to oil-producing countries, but now a lot of that money remains in the U.S. In theory, that supports capital spending and business investment. Economists still expect the shock to negatively affect consumer spending, but not as much as might have been the case previously. "Households have fantastically strong balance sheets with a lot of extra liquid assets that were accumulated over the course of the pandemic," said Stephen Stanley, chief economist at Amherst Pierpont. "I'm guessing they were hoping to spend that money on something more fun... It's going to be painful and more specifically for certain households, but in the aggregate the household sector has more money to deal with this kind of shock." Stanley said for every 90 cents per gallon move higher in gasoline prices, growth slows by about a half percent. He said it also increases consumer inflation by about a percentage point. The consumer price index, including energy and food, was up 7.5% in January on an annual basis, and the inflation gauge is expected to be up 7.8% in February. Interest rate risk Swonk said the Federal Reserve's interest rate hikes could also be a drag on the economy, but surging inflation makes it necessary for the central bank to start the hiking process even with a possible slowdown. The Fed is expected to start raising rates next week and boost them as many as six more times this year. "We're coming in hot and with a lot of momentum," she said Citigroup's David Bailin said he doesn't expect a recession from rising oil, but he says the central bank could trigger a recession if it is too aggressive in responding to inflation. "I think we're pricing in a supply shock to energy commodities, and we are also pricing in a period of longer inflation... It's price shock combined with supply shock," said Bailin, chief investment officer and head of Citi Global Wealth Investments. He expects the inflation to be temporary, but adds it could affect the Fed's view anyway. For investors, he's recommending caution. "As an investor, trading in this environment is treacherous," said Bailin. He said investors should have positions in companies that process or transport natural resources and will benefit from rising commodities prices. "I don't think this is a good time to trade unless you're moving from fixed income to preferred stock," or to quality dividend-paying stocks, he added.

A display shows fuel prices at a gas station in New York City, March 7, 2022.

Andrew Kelly | Reuters

Much higher oil and gasoline prices increase the chances for a recession, but economists say the U.S. economy is resilient and should dodge one for now.