Surging oil prices caused by the Russia-Ukraine conflict not only threaten to increase inflationary pressures. The surge could cause a stagnant U.S. economy as shoppers devote more money to rising energy bills and less money to everything else – the very definition of ‘’stagflation.’’
While ‘’stagflation’’ may have been a reasonable argument in the past, we think that current economic circumstances make it less likely. Take, for example, the shrinking chunk of the American household budget that’s spent on energy. At 6.5% of income currently, energy costs are below the five-decade average of 8.1%, and well below the 10%+ level of 2008 when U.S. benchmark oil prices leaped to $140 a barrel.
Higher oil and gasoline prices are painful, but we think the burden shouldn’t be enough on its own to take a big bite out of this year’s expected U.S. GDP growth of 3.7%.1
Household balance sheets are in better shape to weather a jump in oil costs after many Americans
used pandemic stimulus payments to pay down debt. Household debt as a percentage of personal income was 85% as of Q3 2021, the lowest in twenty years (excluding pandemic distortions), according to Bloomberg data. Meanwhile, low-skill wages grew by 4.2% year-on-year in January, the largest increase in 19 years, according to the Federal Reserve Bank of Atlanta’s Wage Tracker data.2 Pay for high-skilled workers was also rising, according to the Atlanta Fed, with January’s 3.9% year over year bump up being the biggest in 12 years. Overall, Americans are in good financial health and should be able to weather a temporary jump in energy costs due to the Russia-Ukraine conflict.
Also keep in mind that an energy shock is harder to create today compared to the 1970s. Worldwide, there’s growing efficiency in the use of oil to generate economic growth. The so-called energy intensity of global GDP is half of what it was fifty years ago. It currently takes 0.43 of a barrel of oil to produce $1,000 of GDP versus nearly 1.0 barrel of oil in 1973, according to Columbia University’s Center on Global Energy Policy.3
More efficient use of energy isn’t a magic bullet, of course. Stagflation is possible should oil prices set new highs during the conflict. However, we think the odds of a repeat of the 1970s and ‘80s is low. The American economy is far more services oriented than 50 years ago, household balance sheets are stronger, and the country is now a net exporter of energy versus being a major importer in ‘70s.
While the underlying economic supports are strong, the markets still have to wrestle with many unanswered questions, which suggests to us that volatility will remain elevated. The uncertainty around Ukraine only compounds the bigger macro questions that were already moving markets this year. Questions such as how quickly will the Federal Reserve raise interest rates, and whether the Fed would deliberately cause a recession if that’s what’s needed to defeat inflation? Those questions are no less important as the Ukraine conflict continues.
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This commentary is written by Horizon Investments’ asset management team. For additional commentary and media interviews, contact Chief Investment Officer Scott Ladner at 704-919-3602 or firstname.lastname@example.org.
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