Today we are fortunate to be able to present a guest contribution written by Rashad Ahmed (Andersen Institute for Finance and Economics). The opinions presented are solely those of the author. A version of this article was posted on the ARC blog.
In less than a month, global oil prices rose above $100 per barrel following US and Israeli strikes against Iran. West Texas Intermediate (WTI), North America’s crude benchmark, rose from around $65 and hit a high of around $116, while Brent, the global benchmark used to price crude, rose from $70 to $118. The key question now is whether high oil prices continue and materially increase the risk of a US recession.
Historically, the macroeconomic consequences of oil shocks have depended less on oil prices than on the source and persistence of shocks, policy responses, and the underlying economic conditions. At that rate, today’s economy looks very different from the one that faced the oil crisis of the 1970s.
The US economy’s reliance on oil has declined dramatically over the past century. Energy costs as a share of GDP have more than halved since the 1970s, reflecting the gains in manufacturing and the growing dominance of services. The shale boom has transformed the United States from a major exporter to one of the world’s largest oil producers, partially mitigating the domestic impact of higher prices. Meanwhile, deep and liquid derivatives markets allow firms to hedge energy price volatility more effectively than in previous years.
Still, an oil shock would be particularly hard on a cooling economy that has already faced a series of supply shocks. To assess the current risks, it is useful to first examine the economic background and consider what the markets are showing.
Economic Background
The labor market entered 2026 with limited momentum. Employment remained subdued, with little change in earnings for the year as firms grew cautiously amid tax uncertainty and rising international tensions. In energy-intensive sectors including aviation, agriculture, manufacturing, and transportation, rising oil prices add pressure to higher input costs.
Inflation, meanwhile, was already above the Federal Reserve’s two percent target before the conflict began. Consumer prices rose 2.8 percent in the year to January, while core inflation excluding food and energy rose 3 percent. A sharp rise in oil prices is clearly inflationary, raising costs for both companies and households. The results are reflected in higher prices of refined products such as gasoline, diesel, and jet fuel, as well as oil-consuming materials such as plastics and fertilizers. Markets responded accordingly: one-year inflation in the US rose to 3.2 percent, up 70 points from 2.5 percent on February 27.
Households also entered the year with a real boost in income. High energy prices can further erode disposable incomes by reducing purchasing power and shifting money towards fuel and utilities and away from other goods and services, creating a wider demand curve. If high oil prices persist, what starts out as an inflationary effect may end up justifying demand for destruction and deflation. These pressures can spread to consumer-facing sectors, spreading the effects of high oil prices throughout the economy. The drag effect on consumers may also weigh on equity markets and investor sentiment, reinforcing many of the economy’s weaknesses.
A Message From Markets
Forward-looking market indicators suggest that the risk of a recession has increased significantly since the start of the conflict.
The prediction markets now offer the highest possible downside. In Kalshi, the probability of a recession in the US in 2026 almost doubled from 20 to 39 percent, with the same movement seen in Polymarket. Institutional forecasters also revised their chances of a recession higher. Goldman Sachs raised the odds of a 12-month recession to 25 percent, citing rising oil prices alongside a sluggish labor market, while Moody’s put the odds of a recession above 50 percent following higher oil prices. Economists polled by the Wall Street Journal put the likelihood of a recession at 32 percent, up from 27 percent last month.
Oil prices, however, are only one part of the broader macro picture. In Ahmed and Chinn (2024), we develop a recession probability model based on market indicators including oil prices, US and foreign yield curves, stock market returns and volatility, and broader financial conditions.[1] Updating the model with current data, including a 62 percent increase in oil prices over the past three months, produces a 12-month recession probability of 36 percent, which is closely aligned with market forecasts and survey forecasts, and between Goldman Sachs and Moody’s estimates.
A fictitious exercise highlights the importance of oil shocks. The probability of a recession predicted by the model drops to 19.7 percent if we assume no change in oil prices, suggesting that recent price increases have had a significant economic impact on recession risk.
Nevertheless, several traditional indicators of recession remain stable. The US yield curve is not inverted. The yield curves of other countries, such as those of Germany, Japan, the United Kingdom, and Canada, also remain steep. The S&P 500 index is currently down about 8.5 percent from its peak, about half the size of last year’s steep decline and only a third of the 2022 bear market. Credit spreads have widened again, albeit modestly so far. However, financial conditions could quickly deteriorate if the conflict continues to escalate.
The Fed’s response
Historically, oil shocks have preceded many, but not all, recessions (Figure 1). Even the country’s oil shock (shaded in red) did not lead to the same recession.[2] The historical record instead emphasizes three points: the economic consequences of oil shocks are not reactive, the ongoing issues of shocks, and monetary policy responses that play an important role.
The geopolitical oil shocks of 1973 (Yom Kippur War), 1979 (Iran Revolution and Iran-Iraq War), and 1990 (Gulf War) were followed by economic collapse. In each episode, oil prices rose sharply and remained high for at least a year, inflation accelerated, and the Federal Reserve tightened policy aggressively.
In contrast, the oil shocks associated with the 2003 Iraq War and the 2011 Libyan civil war were not followed by recessions, and monetary policy was not materially tightened. The 2022 oil shock following Russia’s invasion of Ukraine coincided with the Fed’s massive tightening to contain inflation during the pandemic. Nevertheless, the economy eventually avoided a recession, supported in part by the residual effects of the aggressive monetary policy initiated during the 2020 pandemic.
Current policy expectations remain cautious. The Federal Reserve’s latest projections do not include a sharp increase in inflation or policy rates. And while futures markets have priced in a rate cut expected at the start of the year, they expect little change in policy rates by the end of the year. But with inflation risks and recessionary risks pulling policy in opposite directions, the outlook for interest rates remains unusually uncertain. Therefore, market expectations of unchanged policy rates may be less likely than a major move.
Whether an eventual decline will occur will depend on the persistence of higher oil prices, the Federal Reserve’s policy response, and whether repeated supply shocks strengthen inflationary forces. Persistent inflation risks may prompt monetary tightening ahead as policymakers seek to keep inflation expectations firm.
At the same time, events in Iran continue to evolve rapidly. In a worst-case scenario – one where the conflict widens and escalates – the destruction of demand could be widespread and financial conditions could deteriorate significantly. Under such conditions, the risks of a recession could increase significantly, possibly changing the priority of the Federal Reserve from containing inflation to supporting the economy by reducing interest rates.
[1] A version of the NBER working paper can be found here:
[2] The red-shaded world oil shocks include: the Yom Kippur War (1973), the Iranian Revolution and the Iran-Iraq war (1979), the Gulf War (1990), the Iraq War (2003), the Arab Spring and the Libyan Civil War (2011), the Russia-Ukraine War (2022), and the current US/Israel-Iran conflict (2026).
