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Oil Prices Are Breaking an Old Recession Tradition

You don’t have to look far these days for evidence of a looming recession: The housing market is slumping, the bond market’s yield curve has inverted , and the Federal Reserve is projecting that the unemployment rate will rise in 2023. But another noteworthy factor that was part of that gloomy picture just a few months ago has disappeared: the price of oil.

In the three most recent recessions before the pandemic, oil soared in the run-up to the downturn. We saw prices rise earlier in the year, only to cool off over the past six months. This is one of the more promising developments for people who are hoping the overheated US economy will be able to achieve a soft landing. It also raises questions about whether oil is as salient an economic indicator as it has been in the past.

Historically, soaring oil prices have been bad for the US economy because they squeeze US consumers and producers, and often are happening when the Federal Reserve is raising interest rates to rein in inflation. The 1990 recession began at the onset of the Gulf War when oil prices doubled. Again, prices surged to $33 a barrel from $12 a barrel before the economy tipped into recession in early 2001. And the 2008 recession was even worse because oil prices were still surging after the economic contraction had begun, so consumers were hit by a slumping housing market and higher energy costs.

When oil prices soared after the beginning of the war in Ukraine early this year, it appeared that history might be repeating. Between November 2020 and June 2022, the price of a barrel of West Texas Intermediate crude rose to $120 from $40. The Federal Reserve made its first 0.75% interest rate increase in June in part due to the inflation created by rising oil prices.

But that turned out to be the peak in the price of oil, while economic growth picked up in the third quarter and so far appears to be even stronger in the fourth quarter. There are several reasons to explain why prices have declined: Aggressive rate increases by the Fed cooled off speculation in commodity markets; the White House’s release of oil from the Strategic Petroleum Reserve increased supply; and China’s efforts to control the spread of Covid-19 weakened oil demand there. It all adds up to a reprieve for US consumers and businesses.

With the price of oil now down 35% from its peak, one could argue oil is becoming more of a tailwind than a headwind to economic growth. On Monday, the average retail price of gasoline in the US hit its lowest level since February. Though $3.60 a gallon still sounds like a lot to consumers used to paying less than that in years past, worker incomes have grown a lot over time. Relative to the growth in average wages, gasoline prices are at levels comparable to 2018 — a time when oil prices weren’t making headlines.

So it’s fair to argue that energy prices just aren’t as important to the direction of the US economy as they used to be. A 2020s service-driven economy is less sensitive to energy prices than a 1970s manufacturing-driven economy. The evolution of domestic energy over the past decade makes rising oil prices more of a winners-and-losers dynamic than one where the US economy suffers as a whole. Efficiency gains and the growth of renewables means energy makes up a lower share of household budgets over time — in September, energy goods and services made up 4.5% of household spending, half of what it was in the early 1980s.

We also can’t know whether the decline in oil prices since June will be sustainable. Releases from the Strategic Petroleum Reserve are set to end. China demand could surge as it relaxes Covid policies. If Europe makes it through a tough winter in good enough shape, economic growth and demand for oil in the region could pick up. The oil market still seems structurally undersupplied over the next few years.

But as long as we’re looking for signals in the economy, the price of oil isn’t pointing to a recession in the US right now. In fact, prices are low enough that they’re arguably boosting rather than detracting from growth. Recessions generally don’t happen when worker incomes are growing and energy prices are falling — that’s a good thing to remember at a time when there is so much negativity swirling around.

More From Other Writers at Bloomberg Opinion:

• It’s Clear QE Was a Colossal Policy Mistake: Allison Schrager

• Nasdaq 100 Peak a Year Later: It Was a Bubble: Jonathan Levin

• The World Economy Catches Some Breaks: Daniel Moss

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Conor Sen is a Bloomberg Opinion columnist. He is founder of Peachtree Creek Investments and may have a stake in the areas he writes about.

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