Two questions are dominating the current debate: are oil prices high enough to trigger a recession? Are the markets too optimistic?
Historically, recessions in the United States have been preceded by an oil shock, except for the one triggered by the Covid pandemic. US oil demand is price inelastic: to reduce demand by 10%, prices would need to double or triple, but even without reaching extremes, the increase from $60 to $100 per barrel is still significant. The rise in oil also causes production costs to increase for plastics, fertilizers, and helium, to name a few examples. Since the beginning of the conflict, urea prices have risen by 40%, diesel and jet fuel prices have soared, with consequences on transportation costs.
Price volatility is expected to persist for months after the conflict ends, until production levels return to pre-war levels. However, even with a lasting ceasefire, 12% of oil production is blocked: it will take months to return to full capacity and years to rebuild destroyed infrastructure. Oil prices could therefore remain high for the rest of 2026.
Markets appear relatively calm, but there will be repercussions on the real economy: the IMF estimates that a 10% increase in oil prices will shave 10-20 basis points off global growth. If this crisis lasts until the end of the year, according to estimates from the Dallas Federal Reserve Bank, global growth would need to be revised down by 1.3 percentage points. The concern is not only the direct inflationary effects but especially the second-order effects: contraction in discretionary household spending, rising unemployment, and the risk of recession.
United States
From generators of low-capital cash flows, hyperscalers are now making large investments: this year alone Amazon, Google, Microsoft, Meta, and Oracle will spend about $700 billion. Operating cash flow is increasing, while free cash flow is collapsing. However, investors have overcome concerns about a possible capex investment bubble linked to AI.
Over 25 years, internet traffic has increased by 40% per year, yet internet hardware investments have collapsed as fiber optics have increased infrastructure efficiency. The same could happen with AI, although GPU rental rates and memory chip prices have risen. Moreover, sentiment for software stocks has changed: AI reduces programming costs, leading to cost reductions for customers as well, but putting software business models and potentially social media at risk. As a result, many companies are at risk.
As a percentage of GDP, IT spending is higher than the 2000 peak, and tech stocks represent half of the S&P 500 – a higher share than during the dotcom/TMT bubble. In the US, however, the picture is characterized by strong concentration: in the first quarter of 2026 alone, half of the S&P 500 earnings growth is attributable to just Nvidia and Micron stocks.
Equity valuations have decreased, partly due to the pullback, but mainly because of upward revisions in earnings estimates, which are surprising despite the conflict in Iran.
Generally, estimates lag macroeconomic developments, often causing a disconnect between earnings and stock prices. For example, in 2022 earnings rose until mid-year despite stock prices peaking earlier. Subsequently, earnings declined until February 2023, even though stock prices began rising in the second half of 2022.
US households hold equity securities worth $70 trillion, equal to 220% of GDP, up from 130% in 2000. This wealth has supported consumption despite a weakening labor market. However, consumption largely derives from wages, but signals on this front are not encouraging: non-farm payrolls increased by just 60,000 jobs per month, with moderate wage growth and unchanged hours worked. Spending pressure has reduced the savings rate to 3.9% – a low level, but far from the 1.4% recorded before the Global Financial Crisis.
In the absence of stronger nominal wage growth, energy inflation will compress real wages and households will reduce spending. However, it is unlikely that the wage-driven inflation of 2021-22 will repeat, because at that time the labor market was tight due to early retirements caused by the pandemic; since then, the gap between jobs and workers has narrowed.
Oil prices are fueling inflation. CPI swaps price in more than 3% inflation in the US and Europe over the next 12 months, and if this occurs, since 2020 consumer prices would have increased by 3.9% annually in the US and 3.5% in Europe, absorbing the undershoot following the global financial crisis. Despite the oil surge, long-term inflation expectations remain anchored as wage growth slows while job openings remain stable. This means the Fed will likely cut rates, making hawkish expectations unlikely to materialize.
It will probably take time for bond yields to decline, as supply shocks due to the Middle East war have increased term premiums. Unlike past supply shocks, US corporate margins are high, enabling companies to absorb losses and avoid layoffs, which would otherwise create a vicious circle and recession. But the ability to pass on higher input costs is uncertain and consequently profit margins could suffer. Moreover, fuel costs weighing on consumers could cause a reversal in earnings upgrade trends.
Europe
In 2022, Europe had to source oil and gas outside Russia, but no shortages occurred. At that time, energy price increases exacerbated existing inflation caused by post-Covid supply chain difficulties, increased demand following reopening, and accommodative fiscal and monetary policies.
2026 began with a strong recovery for European markets, then interrupted by the Middle East conflict with earnings at risk of lagging US ones again. At the start of the year, double-digit growth was expected; now, depending on the crisis duration, forecasts range between 5 and 10%. Consensus expects a rate hike from the ECB, but this could be a monetary policy mistake. Germany continues to ease fiscal policy, an option unavailable to other European countries.
On the investment front, this year the value approach has outperformed growth both in the US and Europe, unlike 2025 when it only affected Europe. Despite lower US valuations, the gap with the rest of the world remains wide.
China
As for China, excessive real estate development and high prices persist. New construction starts have dropped 75% from 2019 highs, but completed projects have only fallen 44%, resulting in an accumulation of unfinished projects. Rental yields are the lowest in the world, implying further price declines. Added to this are unfavorable demographic characteristics: the working-age population could shrink by 70% by the end of the century, reaching 700 million people.
China also fears that overcapacity may limit the effectiveness of any stimulus measures, already declining with only slightly positive fiscal and credit impulses. The so-called anti-involution measures, designed to curb excessive competition and overcapacity in various sectors, as well as promote sustainable growth and improve profitability, end up depressing investment across all sectors of the economy.
Conclusions
Although an oil shock does not automatically translate into a recession, it certainly increases the risk. With issues related to oil, rising inflation, and wage growth no longer cushioning households, demand slowdown is likely to intensify during the year. Corporate margins provide a temporary buffer, but fuel costs weigh on consumers, making earnings optimism vulnerable to reversal.
The European economy is weakened, reducing inflation risk but increasing recession probabilities. The ECB will hesitate before raising rates. If the Middle East war continues for a long time, the gains recorded by the manufacturing PMI index could reverse, causing a slowdown in the European economy.
The United States prove more resilient: earnings expectations continue to rise and, despite high valuations and concentrated risk, growth – albeit more fragile – is set to continue.
