Oil Price Surge and Strait of Hormuz Closure: Is a Global Recession Looming?

Oil prices are rising 18% to 20% this morning in Asia, transmitting a massive risk off to markets as fear takes centre stage. Oil prices are the basis of pricing in the economy. A 20% global shortage of oil is now getting reflected in prices which may go up further to the $150 level on Brent. This is the Fear Premium as at these levels there will be demand destruction across the global economy. Oil prices are strongly correlated to food prices, and bring in a cost plus inflation into the entire economy. Monetary policy tightening may be forced onto central banks if this inflation stays elevated for a longer time. Overall these levels of inflation point to an incipient global recession on the back of aggregate demand turning negative as marginal consumers stop discretionary consumption and cut back on non-discretionary consumption.

Supply Shocks and Global Market Contagion

This 20% oil supply cut and the 70% rise in oil prices is a big drag on the global economy. Markets as forward discounting mechanisms are reflecting the economic impact that is going to be evident over the next few months. The trouble is that huge margin calls will get triggered in the more leveraged parts of markets. This will translate into selling in all liquid parts of markets. Asian markets are showing deep cuts with Korea, a leveraged market down more than 7%, Japan down 6% and most global futures down 2%. Gold and Silver which should be rallying as safe haven assets are also down 2% this Asian morning as liquidity needs are being met by selling whatever holdings can be sold in this market.

The main question is when will this war end. The correlated question is when will oil, LNG, fertiliser, sulphur supplies become normalised. The markets were optimistic that self interest will make the US pause the Iran war once its limited objectives were met, like in the 12 day war of 2025. However, the spread of the war into GCC countries, the destruction of no-go areas like water desalination plants and the closure of the Straits of Hormuz are leading to forecasts that the war could last for a destructive few weeks. As oil supply cuts of 20% from the Straits shipping being stopped enter a 10th day, there is panic in the oil markets as countries and companies scramble to source energy needs in international markets. That is being reflected in the markets this morning as stock futures tank and oil prices surge.

The Indian Economic Outlook and Sectoral Impact

Indian markets are seeing a huge cut in the stock futures represented by the Gift Nifty. The oil price hit to the Indian GDP, Current account deficit and inflation will be huge given that India meets more than 85% of its crude oil requirements from imports. We expect retail petrol and diesel price hikes. Cooking gas price was already hiked last week for both consumers and commercial users. Jet aviation fuel prices will also go up. Sectors like paints, aviation, autos, tyres, chemicals and all downstream industries using oil derivatives will see further cuts.

A Growing Threat of Global Recession

However given the liquidity squeeze today, anything that can be sold will be sold, so expect cuts in leading counters, even those not correlated to the oil price, including in gold and silver. With both the US-Israel on one side and Iran on the other remaining adamant, oil could head to $150 within days and could lead to a sharp drop in economic activity and demand. A global recession is a possibility along with increasing social tensions on rising prices and increasing shortages. The only hope is that some sanity prevails and a truce is announced. Trump's son in law and his representative Witkoff are going to Israel today. But the market mayhem continues for now.

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