Why Rising Oil Prices May Not Break This Market

Last night, Donald Trump delivered an address to the nation, offering an update on the ongoing conflict with Iran. The takeaway, at least from my perspective, was fairly clear: the message to the rest of the world was essentially, you deal with the Strait of Hormuz, while we may still have more to do with Iran. Markets initially did not like that framing at all.

Futures sold off heavily overnight. But interestingly, by the time the regular session unfolded, we saw a strong recovery. In fact, from the lows we saw on Friday to where things stand now, the S&P 500 has bounced roughly 4%. That raises an important question: are markets beginning to stabilize, even with oil continuing to surge?

Because while equities have started to recover, oil has been having another explosive move higher. As I’m writing this, WTI is sitting around $113 per barrel, and markets are clearly preparing for the possibility that prices could climb further. The issue now is no longer just whether oil is rising, but what that rise actually means for growth, inflation, and the broader market outlook.

In my last update, I focused on one specific piece of that puzzle. I asked: how high would oil need to go before it becomes a true macro problem? More specifically, how high would oil need to push inflation before fiscal dynamics start working against markets instead of supporting them?

Using that framework, I estimated that oil would likely need to reach around $200 per barrel before it created the sort of inflation shock that could turn fiscal flows decisively negative in real terms and push the economy into a genuinely dangerous zone. But that analysis looked at only one slice of the problem. It answered an important question, but not the whole question.

That is where the broader modeling comes in.

Looking Beyond a Single Variable

To go deeper, I turned to Deep Minsky, the institutional system dynamics framework we’ve built at Modern Macro Technologies. This is one of the core tools behind the forecasts we produce. It allows us to simulate how different macro shocks, policy changes, and financial conditions ripple through the economy over time.

The key advantage of this type of model is that it doesn’t assume the economy is sitting in some neat equilibrium state. Most conventional models do exactly that. They start from balance, apply a shock, and then estimate how the system returns to balance. But that isn’t how real economies work.

The economy is a nonlinear, evolving system made up of interacting sectors: households, firms, banks, the financial system, the Treasury, the central bank, and the rest of the world. Initial conditions matter. Debt levels matter. Sector balance sheets matter. And feedback loops matter. A system dynamics model is much better suited to capturing those relationships than a static equilibrium framework.

So I ran a simulation using current conditions, shocking the system with elevated oil prices beginning in early 2026. In this run, I modeled oil staying a little above $100 per barrel and then traced through the likely effects on inflation, growth, household finances, firm behavior, and equity valuations.

What Happens First: Inflation Rises, Growth Slows

The first-order effects are exactly what you would expect.

When oil prices rise, the overall price level rises. Inflation jumps. Real output softens. In the simulation, oil staying above $100 a barrel almost immediately caused inflation to nearly double before gradually easing lower and then moving sideways at a still elevated rate. As long as oil remains high, the model suggests you can expect roughly 1% to 3% of additional inflation over the coming year.

That higher price level also puts pressure on real growth. If energy becomes more expensive, the input costs of the whole system rise. That drags on real output. So yes, elevated oil is a headwind for the economy. There is nothing controversial about that.

But the more interesting question is whether that headwind is strong enough to derail the equity market in a lasting way.

The Surprising Part: Equities Can Still Hold Up

This is where the simulation gets especially interesting.

Even after introducing the oil shock, the model showed that the equity trajectory actually moved higher than the baseline in the first several months after the shock. There was some moderation later on relative to the baseline path, but by the end of the run, equities were still more or less on track with where they would have been had the oil shock never occurred.

That may sound counterintuitive, but it makes sense once you think through the mechanics.

As long as the system is bending rather than breaking, and as long as fiscal flows continue to inject enough income into the private sector, firms can keep functioning. They can pass along higher input costs. Profits can still be realized somewhere in the system. Credit creation can continue. The economy slows, but it does not collapse.

And that distinction matters. A slowdown is not the same thing as a systemic break.

The critical issue is whether the income flowing into the economy remains sufficient to validate the outstanding claims sitting on private balance sheets. If fiscal flows are still adding net financial assets in real terms, and if credit creation continues, then the business sector can remain surprisingly resilient even in the face of a significant oil shock.

Who Really Takes the Hit? Households

Where the damage shows up much more clearly is in the household sector.

The simulation showed a sharp decline in the household share of income relative to baseline. In plain English, households lose purchasing power. They get squeezed. The pain is real, and it is especially severe for lower-income households, who are hit hardest by rising energy and living costs.

So I want to be very clear here: saying the system can withstand higher oil is not the same thing as saying there is no damage. There is damage. It’s just not distributed evenly.

In fact, one of the most frustrating aspects of the current environment is how perverse that distribution can be. Households suffer, especially the most vulnerable households, while the broader system may still keep functioning because income continues to circulate elsewhere and the private credit system continues to validate itself.

That sounds harsh, but it is an important distinction. Macro resilience does not mean household comfort.

Why This Is Not 2008

One reason the system appears more resilient today than many people might expect is that household balance sheets are very different from where they were going into the Great Financial Crisis.

Back then, the consumer was massively overleveraged. Household debt relative to GDP was much higher, and the household sector was central to the fragility of the entire system. When households broke, they took a large part of the credit structure down with them.

Today, that is much less true.

Households, relative to the rest of the private sector, are actually less leveraged than they were heading into 2008. That means they are still vulnerable to higher prices, but they are less likely to be the direct source of a systemic credit collapse. The business and financial sectors can continue operating even while households are under meaningful pressure.

That is a crucial reason why an oil shock today does not necessarily produce the same market consequences it would have produced in an earlier cycle.

The Real Breaking Point Still Looks Much Higher

All of this brings us back to the same core conclusion.

Yes, higher oil raises inflation.
Yes, it slows real growth.
Yes, it hurts households.

But unless it rises far enough to undermine fiscal support in real terms or to shut down credit creation, it does not necessarily trigger a lasting bear market in equities.

That is why I still think the critical level is somewhere around $200 oil. At that point, the inflation impulse would likely become strong enough to create a much more serious macro break. Below that threshold, the system may bend, but it probably does not snap.

And based on the Deep Minsky runs, that means the most likely outcome from here is not a market collapse, but a market that works through volatility and eventually stabilizes.

Where I Stand Right Now

At this stage, I do think we may be close to a reversal in markets. The bounce off the lows has been meaningful, and the broader fear around the Iran conflict, at least in terms of immediate market pricing, appears to be easing somewhat.

That said, I’m not ready to declare an all-clear.

We are tracking a number of signals right now, and not all of them are aligned yet. Volatility remains high, and in this kind of environment it makes sense to remain patient until the broader setup becomes more convincing.

Still, the longer-term outlook remains constructive in my view. I do expect markets to recover from this volatility over the remainder of the year, and I would not be surprised to see new highs once this washout process finishes playing out.

The bigger point is that the selling we are seeing right now did not begin with Iran. It goes back to the end of last year, when markets were already overpriced relative to underlying flows. That created a fragile backdrop. The geopolitical shock simply accelerated a correction that was already primed to happen.

So the current environment, in my view, is best understood as a combination of two things: a market that was already vulnerable, and an external shock that intensified the selling. That is very different from saying the entire macro structure is breaking down.

At least for now, I do not think it is.

Final Thoughts

The oil spike matters. It matters for inflation. It matters for households. And it matters for how markets price risk in the short run.

But if you step back and look at the broader macro picture, the message is more nuanced than the headlines suggest. Elevated oil prices do not automatically mean a recession, and they do not automatically mean the start of a major bear market. A lot depends on whether fiscal support remains intact and whether credit creation keeps functioning.

Right now, the evidence suggests the system is under pressure, but not yet at the point of failure.

That means this is still a market environment where patience matters, macro context matters, and understanding flows matters far more than reacting to every headline.

If you want the full breakdown, including the chart work and Deep Minsky simulation, I’ll link the video below so you can watch the full update.

Watch the full video here: