Higher crude prices tied to the conflict in the Middle East are now a central risk for the U.S. economy, Morgan Stanley said in a client note on Friday. The firm’s analysts, led by Michael Gapen, emphasised that whether oil’s effect falls mostly on inflation or on growth depends on how much prices rise and whether elevated energy costs begin to curb demand.
"Oil price shocks create convexities and nonlinearities," Morgan Stanley wrote, warning of a distinct split in outcomes. The note said that modest increases in oil typically raise inflation and weigh on activity, while much larger jumps can erode demand to the extent that negative growth effects become dominant.
The bank identified several indicators it will monitor to determine if and when the balance tilts from inflation pressure to growth damage. The first of those gauges is retail spending. Morgan Stanley noted that oil shocks historically reduce consumers’ spending on goods relative to services, and that the impact should show up as weaker retail sales excluding gasoline. The bank also highlighted timing for the key data point: the March retail sales report will not be released until April 21.
Labour market readings to date have shown resilience. In its note, Morgan Stanley projected March headline payrolls to increase by 60,000 and private payrolls to rise by 70,000, adding that initial jobless claims do not indicate that layoffs have picked up.
Business sentiment represents another area of concern. The bank pointed to the National Federation of Independent Business confidence measure, saying a decline in sentiment would matter because uncertainty shocks tend to reduce payroll growth the further NFIB confidence falls below 100.
Financial markets could provide an early market-based read on whether rising oil prices are beginning to destroy demand, Morgan Stanley said. In particular, the bank suggested inflation-linked securities such as TIPS might function as a high-frequency indicator of market views about demand destruction if oil continues to climb.
Taken together, the note frames higher oil as a contingent risk that requires watching a mix of real economy metrics and market signals. Retail sales excluding gasoline, upcoming payroll figures, NFIB sentiment and the behaviour of inflation-linked securities are the specific data points Morgan Stanley will use to monitor whether the economy moves from an inflation-dominated response to one where growth is materially impaired.