Moody's Warns U.S. Economic Recession Probability Reaches 49% Within 1 Year! Exclusive Interview with Moody's Chief Economist

How does the energy crisis worsen the K-shaped divergence in the U.S. economy?

Moody’s Analytics Chief Economist Mark Zandi issued a warning in the latest outlook report, “Iran Oil Shock”: the closure of the Strait of Hormuz not only directly pushes up U.S. inflation but also strikes a heavy blow at the most vulnerable point of the U.S. economy. Moody’s estimates that the probability of a recession in the U.S. within the next year has reached 49%, just one step below the 50% warning line.

“All policies are flying in the air—trade policy, immigration policy, foreign policy,” Zandi told First Financial. “Washington has released too much drama.”

K-shaped divergence and recession under energy shocks

Zandi believes this energy crisis is a heavy blow to American consumers, and this impact is showing extreme divergence in the context of a “K-shaped economy.”

“Every one-cent increase in gasoline prices costs American consumers an extra $1.4 billion annually. Simply put, if oil prices stay at current levels, Americans will spend an additional $70 billion at the pump by this time next year,” Zandi wrote in the report. If oil prices remain high, due to spillover effects across multiple industries, consumers will need an extra $150 billion next year to buy the same goods and services.

Zandi states that a larger proportion of low-income households’ wages will be spent on energy and essentials, making them the first victims of rising oil prices, reflected in a real loss of purchasing power. According to the American Automobile Association (AAA), as of March 24, the national average gasoline price was $3.977 per gallon, nearly 35% higher than a month earlier.

In contrast, the top 20% of earners nationwide, with annual salaries above $175,000, previously benefited from stock market wealth growth, showing strong resilience and accounting for 60% of total U.S. consumption. However, Zandi warns that this wealth-driven consumption support is highly susceptible to stock market corrections: “The current strong consumer spending among high-income groups largely stems from soaring stock valuations… but if stock valuations become excessive and a bubble bursts, it will undoubtedly undermine the positive momentum of consumer spending. At that point, the U.S. economy will struggle and is very likely to slide into recession.”

Over the past month, the S&P 500 and Nasdaq have fallen by 5.6% and 6%, respectively.

Zandi further analyzes that the surge in living costs caused by rising oil prices has completely offset all the dividends expected from the “Big and Beautiful” Act. Originally seen as an engine for economic growth, tax cuts have now become merely a “painkiller” to hedge against high oil prices. Although U.S. domestic oil production is currently sufficient to meet internal demand, under the global pricing system, American consumers cannot remain unaffected. Due to ongoing doubts about the sustainability of energy producers’ price fluctuations and their slow response in expanding production and hiring, the pain from rising oil prices is immediate, while the benefits are delayed and weak.

Zandi emphasizes that, all other conditions being equal, if oil prices average close to $125 per barrel in the second quarter of this year, a recession in the U.S. will occur rapidly.

The Fed’s “Dilemma”

Before the energy crisis, the Federal Reserve was caught between seemingly stable economic growth and a weakening labor market. The oil shock instantly shattered this balance.

Rising energy prices have triggered deep concerns about inflation and even stagflation. According to the latest Fed watch tool from the Chicago Mercantile Exchange (CME), the market expects over a 70% chance that the Fed will hold steady until the end of the year, with about a 15% chance of rate hikes.

A month ago, Zandi predicted the Fed might cut rates two to three times this year. But with the outbreak of the oil crisis, that forecast is now at risk of being completely overturned. Zandi states that every $10 increase in oil prices typically adds 15 to 20 basis points to inflation. If oil prices stay high, U.S. inflation could rise to as high as 4% later this year.

Amid highly volatile economic expectations, the Fed will face a turbulent transition under new Chair Kevin Warsh. “This is definitely the most divided FOMC in decades. At least in my 35 years as an economist, I’ve never seen such disagreement,” Zandi told reporters.

This unprecedented division is reflected not only in views on inflation and employment but also in how the new chair will lead the overall policy. Zandi believes Warsh faces an extremely challenging task: “You can easily imagine a scenario where the new Fed chair Kevin Warsh disagrees with the committee’s final decision, even voting against the FOMC. That would be unprecedented. It would confuse markets and greatly increase volatility.”

(This article is from First Financial)