Key Points
- Brent crude June ’26 futures are testing resistance at $110 per barrel.
- The S&P 500 indicates a bull market.
- However, the S&P 1500 Containers & Packaging Index ($X3BF) threatens a primary downtrend.
- The bond market is growing restless as the risk of fiscal dominance grows.
Brent crude (June’26) futures are testing resistance at $110 per barrel, having climbed more than 20 percent from $90 per barrel on April 17. Peace talks, or rather talks about peace talks, have reached an impasse, triggering a sharp rise in crude prices as global markets face the prospect of lengthy supply shortages.
Both the US and Iran believe they have the upper hand, and it will take time to force either party to capitulate. The effectiveness of the US blockade of Iranian ports will depend on the US Navy’s ability to interdict the estimated 160 million barrels of crude in tankers outside the Persian Gulf that Iran had built up ahead of the blockade.
Physical shortages have so far been limited to Asian markets, with China absorbing most of the shortfall by drawing on its large reserves, estimated at 1.2-1.3 billion barrels. However, some Asian refiners have been forced to cut production runs due to shortages.
Shortages in Europe have largely been met by increased purchases from the US, which is drawing from its roughly 400 million barrels in strategic petroleum reserves (SPR).
Some rough arithmetic tells us that physical shortages will start to bite at the end of May, three months after the outbreak of the conflict:
- One month of crude shipments already on the water at the end of February.
- One month (400 million barrels) of IEA coordinated releases from reserves, excluding China.
- Another month (400 million barrels) of estimated drawdown from reserves by China before they reenter the market to replenish stockpiles at higher prices.
A resumption of Chinese purchases would drive crude prices towards $200 per barrel.
We expect GDP to contract in line with energy shortages, and a global crude oil shortfall of roughly 12 million barrels per day will likely trigger a global recession.
Further releases from reserves are possible, but they will likely be far smaller and done in conjunction with IEA-coordinated measures to reduce consumption. Lower speed limits and petrol rationing are the obvious starting point. However, diesel shortages will directly affect mining, agriculture, and long-haul transport. Jet fuel prices are also skyrocketing, forcing the aviation industry to raise prices and cut flights.
Secondary impacts from supply chain disruptions due to shortages of helium, sulfur, and fertilizers are expected to pose further challenges for the global economy. Helium is essential in the production of semiconductors. Sulfur is used extensively by the mining industry for refining copper, gold, and silver. Fertilizer shortages will restrict agricultural production, especially in emerging markets.
Conflict in the Persian Gulf has had little impact on the S&P 500 so far, but the Dow Jones Transportation Average plunged more than 13 percent last week.
The S&P 500 continues to signal a bull market, with a breakout above 7000, driven by strong first-quarter earnings. We expect the index to retrace to test its new support level.
However, the Dow Jones Industrial Average has yet to break resistance at 50K to confirm the S&P 500 bull signal. A reversal below 49K would suggest another correction.
AI-driven spending is keeping the economy afloat, but the S&P 1500 Containers & Packaging Index ($X3BF) indicates that activity on Main Street is slowing. A fall below primary support at 285 would signal a primary downtrend.
10-Year Treasury yields strengthened to above 4.3%, fueled by rising inflation expectations and widening fiscal deficits.
The budget deficit is inordinately high relative to the low unemployment rate of 4.3% and is expected to rise further as the US government increases defense spending and onshores critical supply chains. Before the 2008 global financial crisis, the deficit as a percentage of GDP was typically kept below the unemployment rate, a sign of prudent fiscal management.
However, Congress demonstrates little inclination to rein in spending. The bipartisan Congressional Budget Office (CBO) warns that federal debt held by the public will soon exceed its World War II high relative to GDP.
The likely outcome is fiscal dominance, where the Fed sacrifices its mandate for price stability to support a struggling Treasury market. High inflation and negative real interest rates seem inevitable.
Conclusion
We expect crude oil shortages to start restricting economic activity from the end of May. Further releases from reserves may delay an economic slowdown for a few more months, but the outcome is irreversible. Even a reopening of the Strait of Hormuz after the end of May would take time to offset the supply shortage and would be unlikely to avert a recession.
The S&P 500 signals a bull market, but investors should be cautious about treating this as a buy signal. A bear signal in transportation and containers & packaging would strengthen the bull trap warning.
Rising inflation and ballooning fiscal debt, with negative real interest rates, seem inevitable.
Acknowledgments
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He founded PVT Capital (AFSL number 546090), which provides income and growth strategies to wholesale clients.
Colin also co-founded Incredible Charts and writes the popular Patient Investor newsletter.
Using a top-down approach, Colin identifies macro trends in the global economy and then combines fundamental and technical analysis to evaluate opportunities in sectors that stand to benefit.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
