We expect the recent rise in oil prices to be a modest headwind to U.S. economic activity while supporting inflation.

How sensitive is the U.S. economy to rising oil prices? A popular view is that growing U.S. energy output has largely immunized the economy against the adverse effects of pricier oil. As evidence of this decrease in sensitivity, many point to the 2014–2016 experience, when a collapse in oil prices did not lead to the expected material rebound in economic activity.

While we agree that the U.S. economy’s overall sensitivity to oil prices has evolved, in large part due to a rapidly shrinking energy trade balance, we caution against extrapolating too much from the 2014 experience. In the near term, diminished pipeline capacity and other bottlenecks will likely curb the acceleration in investment growth that would otherwise accompany higher oil prices.

As a result, we expect the recent rise in oil prices to be a modest headwind to U.S. economic activity while supporting inflation.

The late-2014 oil plunge: Past may not be prologue

OPEC’s November 2014 decision to maintain output despite already elevated global production and inventories triggered a slide in global crude oil prices of nearly 75% through early 2016. Historical patterns would indicate that such a drop in oil prices should have boosted overall economic activity in the U.S. – a net oil importer – by increasing households’ real purchasing power and boosting corporate profits. Yet U.S. economic growth rates were actually lower during this period.

One of the principal drivers of the atypical economic response was the collapse in U.S. energy investment and the knock-on effects on other upstream industries, which together greatly reduced the net economic benefits of cheaper oil. For instance, U.S. natural gas and oil-directed rig counts fell by 80% between the end of 2014 and early 2016, subtracting nearly 0.5 percentage point from U.S. real GDP growth.

However, with oil prices now rising again, we caution against inferring too much from the 2014–2016 experience. While the decline in the U.S. oil trade deficit over the past five to 10 years may ease the economic headwinds, some key factors will likely constrain the potential positive economic impulse from higher energy investment:

Shortages in skilled labor and drilling and pressure-pumping equipment, as well as diminished pipeline capacity in key producing basins, will limit U.S. oil producers’ ability to ramp up capital spending.

The Trump administration’s potential tariffs on steel and aluminum , key inputs into energy drilling equipment, could also reduce the economic value of additional investment.

As such, U.S. producers will more likely apply the benefits of higher prices to balance sheet repair rather than investment, while consumers will feel the burden of higher gasoline prices. We would expect equity share buybacks and dividend distributions to increase, partially offsetting the hit to real purchasing power; however, on net, rising oil prices will likely act like a regressive tax on consumption.

Bottom line

While we do not expect the rise in oil prices to have a big negative impact on the overall U.S. economy (at least not of the magnitude seen in past periods), we caution against being too complacent in assuming that growing U.S. energy production will insulate the economy. We think investors should expect some economic headwinds and support for rising inflation.

For more of our views on oil and other commodities, see our 2018 Commodities Outlook.

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Greg Sharenow is a PIMCO portfolio manager focusing on real assets, and Tiffany Wilding is a PIMCO economist focusing on the U.S. Both are frequent contributors to the PIMCO Blog.