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The next recession will be caused by an extreme rise in energy/transportation costs.
Hopefully a short thread
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Hopefully a short thread
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The Fed’s commitment to near-zero rates and acceptance of higher inflation sets this up in two distinct ways. 1, as @crudegusher mentioned today, a weakening dollar (which seems almost a certainty going forward) will provide a tailwind for oil prices
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Second, going on 12 years of QE, cheap money has exhausted the best capital opportunities, and despite valuations, has actually weakened the investment opportunity set for companies. Valuations have just risen because they’re the only game in town in a 0% rate world.
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Despite the exhausting of investment opportunities, falling borrowing costs keep moving the threshold lower, making more capital destinations “economical.” This is not relative to the inherent risk, but relative to a 0% interest rate + 3-4% inflation world
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How energy ties in: in a world starved for yield and solid investment opportunities, cap mkts are still closed to energy, the sector with possibly rosiest 3-5yr horizon right now given rock bottom valuations across the board. Add in ESG considerations and you just see lower
capital churn through the space, and impending undersupply. However, cap providers learned (maybe) to not chase a run-up in price (see 2016-2020). This means higher long-run prices/more supply inelasticity from US shale. So prices hang out $70+.
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What has gone largely unnoticed is the flow through effects of $60 oil and $2.50 gas over the past ~4 years. Energy production is an economic multiplier, with the entire economy benefitting from the hardship (low prices) of the energy sector. This works until it doesn’t.
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At some point, energy prices go up across the board. When this happens, all those investment opportunities that barely break even (consequence of a decade of cheap money) fail. Everyone has been benefitting from cheap oil and gas and nobody will sensitize to $80/$4 these days
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This rise in cost of an essential input for ALL economic activities will drive losses across every industry and re-focus capital efficiency, leading to a healthier, balanced economy on the backside, but this time with energy being the silver lining through it all for the US.
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