Gradually Approaching Recession Trading (Guojin Macro Zhong Tian)

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Source: Xuetao Macro Notes

The longer the war drags on, the greater the impact on demand. After four weeks of “transparent trading,” market confidence is gradually being exhausted.

Text: Guojin Macro Song Xuetao / Contact: Zhong Tian

Trump’s pain over the past month has clearly exceeded the level during last year’s tariff war— the issue is no longer whether Trump wants to end it, but how to end it; this has become Trump’s strategic weakness and the main reason for his recent主动“showing weakness.”

The longer the war drags on, the greater the impact on demand—this includes the production demand associated with economic growth and the survival demand linked to social stability. Even if the war ends immediately, the oil supply chain cannot fully recover, and demand will inevitably contract along with supply disruptions, increasing the likelihood of recession.

Approximately 24% of marine naphtha, 20% of LNG, and 30% of ammonia nitrogen fertilizer are transported via the Strait of Hormuz. Against the backdrop of more chemical companies declaring force majeure, we will see extremely widespread effects: from energy-intensive semiconductor supply chains (packaging, solvents) to high-value-added automotive and electrical appliance manufacturing (plastic products, precision instruments).

The decline in the operating rate of cracking units will also lead to a severe shortage of olefin products. Over time, the impact will be amplified through every link in the industry chain: from orders to revenue, and then to the continuity of production and employment stability—affecting the entire chain from production to consumption (income).

Another concern is the impact of fertilizer shortages on grain yields; historically, food shortages have always been accompanied by “war and chaos.” The Russian Ministry of Agriculture has suspended ammonium nitrate exports until April 21, 2026, prioritizing domestic spring planting; other major agricultural countries may also temporarily halt fertilizer exports to prioritize their own needs and social stability. Food issues could become another pain point and source of pressure for many countries.

For the United States, the current reality is that the friction costs embedded in oil prices are difficult to eliminate in the short term. Although as a net energy exporter, the U.S. would benefit from high oil prices and the benefits of low exposure to the Strait of Hormuz in a static framework, the actual situation is more complex.

The “persistence” and “high point pulses” of oil prices jointly determine the pressure on the U.S. economy. A sharp rebound in the short term or maintaining current levels for a longer period would be unfavorable for the U.S.

From a simple “rule of thumb,” every 10% increase in oil prices corresponds to about a 0.1% decrease in real GDP growth, with overall inflation rising by approximately 0.15%. Regarding persistence, if Brent crude remains around $100 throughout the year, the U.S. CPI could be pushed up by about 1%, while a fall back to $80 would result in a 0.5% increase in annual CPI.

For high point pulses, if Brent crude surges to $110-120 in April, U.S. CPI year-over-year could stay at 3.5% for two consecutive months, potentially shaking consumer inflation expectations (especially since retail gasoline prices have risen 33% in the past month, from $3 to $4 per gallon), thereby intensifying Fed’s inflation concerns and prompting a more hawkish stance.

Compared to concerns about persistence, what is more worrying is the “one-time shock” risk of oil prices spiking again in the short term, which could backfire on the U.S. economy.

On one hand, due to transmission lag, American consumers will feel the pain more acutely in the coming months; on the other hand, the decline in transportation supply will cause irreparable shocks to the U.S. service sector. The leisure hotel and retail sectors employ about 1.3 million seasonal workers, accounting for over 20% of non-farm employment. Rising transportation costs will inevitably impact service consumption, affecting seasonal service income and employment, thereby exerting greater pressure on the U.S. economy.

In addition to logical reasoning, there are four signs indicating that recession trading is occurring in the past week.

First is the contango in crude oil futures. Some potential easing events did not push oil prices down, such as Iran selectively releasing ships through the Strait of Hormuz and the “truth and falsehood” negotiations mentioned by Trump. From closing prices, the market is trading at higher crude futures prices. Notably, the near-month (1M-2M) futures spread in crude oil (on March 26) was higher than the longer-term (2M-3M) spread for the first time since the war, indicating high oil prices are suppressing demand.

Second is the correction in U.S. stock performance of assets with earnings certainty. Besides benefiting directly from energy and oil & gas, high-certainty storage assets temporarily served as a safe haven within the tech sector—this pursuit of performance certainty showed a clear change in the face of the “ground troops threat” emerging last week. U.S. stocks experienced their largest weekly decline since the war (March 22-28), with declines exceeding the median of major global equity markets since the war.

Third is the easing of previously intensified rate hike expectations (partly due to CTA position unwinding, but also due to subjective bets), especially as the Fed’s rate hike pricing has reversed in the past two weeks. For economies outside China and the U.S., tightening is merely a surface narrative; under current fundamentals, rate hikes are almost certain to lead to recession, not to mention the possibility of the ECB raising rates three times this year.

Fourth is the evolution of stagflation trades into concerns about fundamentals. In the 21 trading days since the war (up to March 31), the combination of falling stocks, falling bonds, and rising dollar (stagflation-like trades) occurred 10 days, significantly higher than the distribution probability during the Gulf War (or its first five weeks) and also well above the distribution since 1980, indicating the market’s extreme focus on inflation so far.

However, in the past week, U.S. bond yields no longer followed oil prices upward; the U.S. yield curve, after a sharp bear flattening, has begun to steepen again, especially with the faster decline of the 2-year Treasury yield. This suggests that after four weeks of “transparent trading,” market confidence is waning, and attention is shifting more toward growth risks, with recession trades gradually dominating. (See “U.S. Economy Facing ‘Davis Double Kill’” for details)

Recession trades imply that equities and commodities still face the risk of fundamental decline, but bonds may be the first to bottom out. A surge in oil prices to the key levels of 115-120 dollars could trigger a full-blown recession trade; additionally, any deterioration in negotiations, strait disruptions, escalation of bombings, or involvement of Gulf countries could serve as triggers for a comprehensive recession trade.

In short, the end of the war will be marked by when and at what cost the Strait is “semi-open” to whom, but any form of “semi-open” cannot avoid the slowdown of the global economy (compared to pre-war levels). Recession trading is not just “the wolf is coming,” but the stock-bond markets are gradually pricing in the probability of a recession, with many (one-sided) uncontrollable factors still accumulating.

Risk Warning

Trump’s military policy remains highly uncertain, with the risk of U.S. ground invasion leading to loss of control; energy shortages have a significantly greater impact on demand than expected, dragging the global economy into recession; rapid shifts by global central banks could trigger a second round of inflation risks.