The potential of the US war with Iran for an Oil Price Shock

 

 - by New Deal democrat

There is no important economic data being released today, and nothing in the past several weeks has changed my overall economic outlook: to wit, the meme of a “K-shaped” economy is accurate. The top 10%-20% are doing extremely well, and the “wealth effect” of large stock market gains in 2025 driven by AI-related spending, particularly for data center construction is driving their consumption; while the bottom 80% or so are just barely holding their heads above water. The large majority of important coincident data about income, spending, jobs, and sales bears this out.

Meanwhile, needless to say over the past few days there has been a major geopolitical development: it is fair to say that the US is at war with Iran. I don’t have any particular insight into that development, beyond the sense I have had since the 2024 election that T—-p got very lucky in inheriting an economy on the rise in 2017, and he didn’t have a sense of what levers to pull to be able to affect it that much. But he was not so lucky this time, and now he knows where the levers are; and one thing we know about T—-p is that once he finds a lever that works, he keeps pulling it over and over again. That is also on display militarily: as far as he was concerned, pulling the lever of using the military to decapitate a regime worked very well in Venezuela, so let’s do it again! (Rumors are, Cuba is now next on the list).

But one thing I do have some insight into, is the affect of the price of gas on the US economy. So today, let’s take a look at how that is playing out so far, and what to look for in the immediate future.

To begin with, almost all US recessions in the past 50 years have had a component of an “oil shock.” This has a stagflationary effect: driving up prices, and constricting the ability to spend on other things. Typically that stagflationary effect has kicked it at about a 40% increase in price YoY. While I won’t bother with the oil price chart going all the way back to the 1970s, here is what YoY gas prices have looked like this Millennium:

Most significantly, there was an oil price shock in the 2000s that played a role in the Great Recession, and also operated as a “choke collar” on growth during the first five years afterward.

But it isn’t just the increase per se; rather, as I wrote a few weeks ago, it is a function of how much that price increase hits consumers’ wallets. A 40% increase from a very low price is different from a 40% increase from a price that already was slightly constrictive. To show that, let me update the graph I ran then, of gas prices divided by average hourly wages on nonsupervisory peronnel, showing in effect how long a wage earner has to work to buy a gallon of gas:

As you can see, with the last dip in prices during the winter, gas prices were particularly cheap compared with wages; indeed among the lowest such comparisons since the 1990s.

Now let’s take a look at gas and oil prices since the pandemic, right up until this moment.

Let me start with a graph of gas prices for the past three years:

As you can see, there is a seasonal rhythm to these prices, as refiners change from winter to summer blends and back again. Prices tend to bottom at the end of each year, and rise towards midyear.

Further, since Europe and the US worked around the Russian invasion of Ukraine in 2022, gas prices have generally declined YoY:

But now let’s zoom in on the past 12 months:

With gas prices at the pump rising from $2.94/gallon last week to $3.08 as of this morning, gas is at this moment the same price was it was exactly one year ago.

And because global oil prices lead gas prices at the pump (with the caveat that they go up like a rocket and come down like a feather), here’s a look at global oil prices for the past year updated through this morning:

Oil prices were already rising from a multi-year low of $55/barrel during the Holiday season to $67 as of last Friday, as traders were already nervous about the US naval buildup around the Middle East. Then, on Monday, prices immediately rose to $71 and as of this morning to over $76.

That’s a 38% increase since their lows. Of course, I have no insight as to where oil prices will go next month, next week, or even later today, but if that increase holds, it implies an increase in gas prices from their low of roughly $2.80/gallon to about $3.85/gallon. A 40%+ increase would coincide with roughly gas prices at the pump of $4/gallon.

That kind of increase in gas prices at the pump would definitely concentrate consumers’ minds. But even that, in terms of comparisons with wages, would only take us back to 2006 or early 2023 levels. To create a recessionary “oil shock,” all things being equal we would probably need to see prices of $4.50/gallon or above. To bring things full circle, however, in our present “K-shaped” economy, with most households already just keeping their heads above water, I doubt we need to get that far. I strongly suspect that if the US war with Iran causes gas prices to go to $4/gallon, that by itself in the current situation would be enough to bring about a recession tout suite.

ISM manufacturing In February positive, but with a major helping of inflation

 

 - by New Deal democrat

Most official data series remain about one month behind their normal schedule, despite the government shutdown having ended over three months ago. Thus the ISM manufacturing and services reports, as well as the regional Fed manufacturing and services reports, remain the most timely overall barometers of the economy.

In the past few months the regional Fed manufacturing reports have painted a picture of a sector recovering from the impact of tariffs - which continued to be the case in the February reports. This morning the ISM manufacturing report once again confirmed those trends. But also added one renewed source of concern.

To begin with, the headline number declined -0.2 from 52.6 to 52.4. These have been the two highest reading since August 2022:

The three month average, which I use for forecasting purposes, rose to 51.0, the first time this average has shown expansion since January of last year (recall that 50 is the dividing line between expansion and contraction).

The more forward looking new orders component, which in January exploded from 47.4 to 57.1, settled back only slightly in February to 55.8, still a strong reading:

The three month average is now 53.3, indicating a respectable increase in production in the next few months.

Even employment, which has remained a problem child in this series, continued to trend “less bad,” rising from 48.1 to 48.8:

The three month average did remain contractionary, at 47.2.

But the new cause for concern is the sudden spike in prices. These had already been a concern, in view of the tariff situation. In the latter part of last year, these readings had declined into the 50’s, indicating pricing pressure, but not nearly so much as last spring. This month the prices paid reading blew out from 59.0 to 70.5: 

This was the highest monthly reading since June 2022, suggesting that substantial inflationary pressures are building — not a good thing especially when so much of the economy appears to have been stagnating.

As I have continued to note each month, for the economy as a whole the weighted index of manufacturing (25%) and non-manufacturing (75%) indexes is more important. With the exception of one month last year, the services indexes remained in expansion. So I won’t bother with calculating the economically weighted averages today: with both sectors showing expansion, the ISM indexes indicate the economy is likely in expansion now, and the new orders component is positive for the next several months.

But as I concluded last month, and is even more true after today’s report, the caveat remains the important stagflationary pressures which have been showing up in almost all the recent data.

Weekly Indicators for February 23 - 27 at Seeking Alpha

 

 - by New Deal democrat

My “Weekly Indicators” post is up at Seeking Alpha.

Last week commodity prices, and in particular oil, rose sharply again - probably due to what has been unfolding in the Middle East. And the US$ is still losing value. Meanwhile withholding tax payments have faltered somewhat again. Good times!

As usual, clicking over and reading will bring you up to the virtual moment as to the state of the economy, and reward me with a penny or two for my efforts.

Construction spending mainly flat nominally and declining in real terms, except for AI data center-related Boom

 

 - by New Deal democrat

Before I get to the main object of this post, there was a little kerfluffle in the financial markets this morning about a “hot” producer price index number. Specifically, PPI for final demand increased 0.5% in January. Commodity prices also increased 0.3%. The YoY% changes were 2.8%, although raw commodity prices were only up 1.6%. The below graph also shows CPI, which officially was up 2.4% YoY (although a proper accounting for shelter would probably add at least 0.2% to that number):

The bottom line is that inflation is not cooperating with those who would like to see further Fed rate cuts, since it is likely making little if any progress towards the Fed’s goal of 2.0%. Stagflation, anyone?

But let’s turn to an important manifestation of costs and spending in the real world, by way of this morning’s one- and two-months stale report for construction spending in November and December. 

For the month of December, nominally total construction spending (blue, left scale in the graph below) rose 0.3%, although it remains below its recent peak in September, and its post-pandemic peak of May 2024, and is down -0.4% YoY. The long leading sector of residential construction spending (red, right scale) rose a more significant 1.5%, but it also remains significantly below its peak of May 2024, although as I pointed out one month ago, there are certainly signs of “green shoots,” i.e., a bottoming process:

The picture is somewhat different when we account for the costs of construction materials. These rose 1.8% in November and another 0.9% in December to near its all-time highs:

On a YoY basis, they are also up 6.6%.

As a result, in real terms both total and residential construction spending fell, by -1.5% and -0.4% respectively:

The overall trend remains slightly negative for total construction spending, although residential construction spending has been trending sideways. Hence, small signs of “green shoots” by way of forming a bottom.

One big negative is manufacturing construction spending, which declined -2.5% in December, and is down over -15% from its August 2024 peak (recall that the big Boom was a direct result of the Inflation Reduction Act)

So much for tariffs bringing back manufacturing!

What has been powering the positive contributions to total construction spending, as with so much of the economy, is AI data center related spending. Power generation spending rose 0.8% for the month of December and is up 5.8% YoY. Another aspect is the water needed to cool these power plants, which declined -2.5% in December, but is up 8.1% YoY, and made an all-time highs in October:

So once again, we have an economy that is barely holding its head above water, and indeed in real terms the construction sector is declining, with just about the only subsector holding it afloat being AI data center spending, and its stock market-associated wealth effect consumer spending.

More clarity in jobless claims: both post-pandemic seasonality and regime change at work

 

 - by New Deal democrat

As we move further into the calendar year, we are getting more clarity on what has been happening with jobless claims. As a reminder, I look at these because historically they have been a good short leading indicator for the unemployment rate and more broadly for the economy as a whole. And to cut to the chase what I see happening with claims is *both* residual post-pandemic seasonality *and* a change in regime to lower claims that started at mid-year last year.

First, to this week’s numbers: initial claims rose 4,000 to 212,000. The four week moving average rose 750 to 220,750. And with the typical one week delay, continuing claims declined -31,000 to 1.833 million:

The one week delay in continuing claims this week is likely unusually important, because this reports (like initial claims last week) for the week including President’s Day and so had one fewer day that government offices would be open.

Note, though, that the post-pandemic seasonality, in which claims make lows at the turn of the year, rise to highs at mid-year, and then decline back down through the end of the year, looks more apparent now as we see initial claims and their four week average moving higher since January.

But as usual, the YoY% change is more important for forecasting purposes; and it is here that we see continued evidence of a change in regime. On a YoY basis, initial claims were lower -7.1%, the four week average down -2.5%, and continuing claims down -0.8%:

This is the trend of generally lower claims we have seen since the end of last June. This trend is a positive for the economy over the next few months. Again, the reason for this regime change may have to do with the nearly complete cessation in new immigration, and fear and deportations driving immigrants already here not to show up for work or to file claims, leading to lower jobless claims. Since we have also seen a gain in AI data center-related employment, it could reflect a lower number of layoffs in nonresidential construction employment as well.

Finally, since we are close to the end of the month, let’s take a look at what this likely means for the unemployment rate (red in the graph below, left scale) in the next monthly jobs reports:

The downward trend in jobless claims strongly implies a declining trend in the unemployment rate over the next several months, towards 4.2% or even 4.1%.