Historically, oil price spikes have often preceded recessions. However, this pattern only holds when corporate earnings growth is decelerating or negative. With current earnings accelerating, the economy is more resilient, and the market is correctly pricing a lower probability of an oil-induced recession.

The US is more vulnerable to recession from an energy shock now than in 2022. The previous shock was absorbed by a hot labor market, high consumer savings, and a $2T reverse repo facility. All three of these buffers are now gone, leaving the economy exposed.

Historical precedent is unequivocal: central banks do not cut interest rates in response to an oil shock. Despite the negative growth impact, their primary concern is preventing the initial price spike from embedding into long-term inflation expectations. Market hopes for easing are contrary to all historical data.

Despite a major geopolitical shock, Emerging Market currencies have held up remarkably well. In contrast, EM rates markets have shown significant stress, indicating painful positioning squeezes and a reassessment of inflation risks by investors. This divergence signals underlying strength in some areas but reveals hidden fragilities in others.

While initial energy price spikes boost short-term inflation expectations, a sustained shock eventually hurts economic growth. This growth concern acts as a natural ceiling on long-term inflation expectations (break-evens), as markets anticipate an economic slowdown, preventing them from rising indefinitely.

The long end of the bond curve has moved up simply to reflect tighter short-term policy, but has not seen a meaningful expansion of risk premiums. This suggests the market is complacent, underestimating the risk that this oil shock could extend the period of above-target inflation for years, similar to the post-2022 experience.

Unlike past recessions where defaults spike and then recede, the current high-rate environment will keep financially weak 'zombie' companies struggling for longer. This leads to a sustained, elevated default rate rather than a sharp, temporary peak, as these firms lack the cash flow to grow or refinance.

In 2022, a hot labor market and high savings from stimulus buttressed the economy. Today, households are already dissaving to maintain spending amid a weakening labor market. An oil shock now adds a 1-1.5% price hike across goods, threatening to push real household consumption to zero and stall the economy.

Unlike the 2021-22 cycle which coincided with post-COVID overheating, Latam economies now boast a more resilient backdrop with lower current account deficits, positive real policy rates, and moderated inflation. This strength, coupled with appealing valuations, provides a substantial cushion against political volatility for local rates markets.