Bank of America warns markets are ignoring a 30% probability of a major oil shock that could trigger a recession.
Global markets are pricing for a soft landing, but they are ignoring the escalating risk of an energy shock that could derail the world economy, according to a new Bank of America report. Strategists led by Sebastian Raedler on May 22 warned of an “Impossible Triangle,” where investors are simultaneously embracing three contradictory propositions: low risk premiums, rapidly depleting oil inventories, and a low probability of the Strait of Hormuz reopening soon.
“The market’s calm relies on three pillars: a moderate oil price rise, resilient US macro data, and an AI-driven earnings boom,” Raedler’s report states. “However, these supports are beginning to wobble.” The analysis points out that since the Iran conflict began, European stocks have only fallen 2 percent while global equities have climbed 4 percent to new highs, a calm that seems inconsistent with the underlying risks.
The report highlights a stark disconnect in market pricing. European equity risk premiums are at 4.75 percent and US high-yield credit spreads are just 275 basis points, both near 20-year lows, suggesting little fear of an economic shock. Yet, data from the prediction market Kalshi shows traders assign only a 30 percent probability to the Strait of Hormuz reopening by the end of June, and just 40 percent by early August.
This complacency is at odds with the reality of global oil supplies. With inventories already heavily drawn down, strategists warn they could hit critical operational levels by June. If the strait, a chokepoint for about 21 percent of global oil trade, remains closed, the only balancing mechanism is “demand destruction”—a sharp spike in oil prices high enough to throttle economic activity, a process consistent with historical energy crises.
A Tale of Two Markets
While equity investors appear placid, other asset classes are flashing red. The bond market has begun pricing in a higher geopolitical risk premium, with recent reports noting that US Treasurys have entered a “danger zone.” This divergence suggests equity markets are overly reliant on the AI narrative to sustain earnings growth, ignoring the macroeconomic storm clouds that are gathering.
The macro data itself is also showing signs of fading strength. In the US, the boost from early-year tax refunds has dissipated, and real labor income growth has already fallen to levels associated with recessions due to inflation. The situation is more acute in the Eurozone, where the May composite PMI for new orders fell to a two-year low of 47.1, signaling a sharp slowdown in private demand.
Bank of America projects that this macro pressure will eventually override the current AI-fueled optimism. The firm forecasts that the 12-month forward earnings per share for the Stoxx 600 will fall by approximately 5 percent from its current record high. This implies a 1 percent earnings decline for 2026, a stark contrast to the positive growth expected by the market consensus. If the Impossible Triangle collapses as the bank’s strategists fear, the current calm in equity markets could prove to be a costly illusion.
This article is for informational purposes only and does not constitute investment advice.
