Editor's Note: While the market is still debating whether the "recession is coming," this article shifts the perspective to focus on the underlying constraints. Currently, the interplay between energy shocks, geopolitics, and monetary policy is reshaping a more complex macro environment. In this environment, central banks no longer have a clear reaction function, the traditional path of rate hikes or cuts is ineffective, and the policy space is "locked."
The article redefines a recession from an "economic outcome" to a "strategic state," which not only compresses growth and employment but also weakens a country's bargaining power, capital attraction, and external reputation, leading to a loss of agency in the global game. Therefore, governments around the world are using fiscal, diplomatic, and even geopolitical means to substitute for monetary tools, essentially buying time for declining growth and avoiding negotiations during a recession.
In this framework, the core of the market is no longer the interest rate path itself but "who can escape constraints and who remains trapped." This difference is first reflected in the foreign exchange and interest rate markets and further transmitted to asset prices and capital flows. When valuations continue to rise amid slowing growth, it may not be due to fundamental improvements but rather expectations of policies that "will not allow a recession to happen."
As energy, capital, and power reweave, macro issues are no longer just economic issues but a systemic game that transcends policy boundaries.
Here is the original text:
This report is not making predictions but attempting to reconstruct a plausible structure: if the current energy shock continues to spill over and evolves into a global recession, what structure will this process present?
This recession is likely to unfold not along the familiar path but in a way that lacks clear historical references, cascading through and gradually amplifying within the financial system. It is important to emphasize that "predicting whether it will happen" and "understanding how it will happen" are two completely different things, and this article is concerned with the latter.
It should also be noted that I do not believe this scenario is necessarily going to occur. Frankly, I am not the type of "smart money" who has been long on crude oil, short on stocks for the past month, and has been holding until realizing profits. My current biggest risk exposure is in the Hyperliquid ecosystem—it has quietly benefited from geopolitical fluctuations and is one of the few assets that has still recorded positive returns in recent years, while the "big seven US stocks" and Bitcoin are generally in a retracement zone.
The reason for bringing up this point is simply to illustrate: the most dangerous thing in the market is never being wrong about the direction, but rather establishing a position first and then constructing a framework to explain the world in reverse.
The problem lies in the fact that this system itself presupposes everything.
Supply shock is one of the few variables that will break conventional economic relationships. In most cases, growth and inflation move in the same direction: the hotter the economy, the higher the prices; as the economy cools, inflation falls. Macroeconomic policies are designed around this relationship, and the underlying logic of the modern central banking system is also built on this assumption.
The Federal Reserve's wording is very typical: "Our dual mandate is to achieve full employment and price stability."
Behind this definition, there is actually an implicit assumption—that growth and inflation are broadly compatible. In the vast majority of cases, this assumption holds true. However, in a specific set of circumstances, they will instead offset each other. Once in this state, the "dual mandate" ceases to be an actionable policy tool and becomes more like an invisible constraint.
This "constraint" is not a theoretical assumption. Since the late 1990s, a pricing environment with stagflation characteristics has accounted for less than 10% of the time in the market. Among the various economic states listed in the table below, it is the rarest but corresponds to the worst asset return performance—especially for most mainstream assets held by the majority.
This is the moment we are in. The current volatility and widespread panic are not because a recession is certain, but because we are in a situation where no matter what the Fed does, it will both solve one problem and worsen another.
Transmission Chain
The diagram below illustrates the nominal and real changes in food and energy-related expenditures in the economy. In other words, it reflects both how much American consumers "actually spent" (quantity) and "were charged" (price).
When growth and inflation rise together, higher prices do not immediately destroy demand. People choose to endure, complain, push for higher wages, and continue consuming. That was the case in 2022, which is why the Fed could continue raising rates in such an environment without triggering an immediate economic collapse. At that time, real consumer spending was growing at nearly 8% year-over-year, showing the economy's capacity to withstand shocks.
Our current year-over-year real spending growth rate is around 2% (compared to nearly 8% during the 2022 energy shock).
In 2022, the Fed was raising rates in an economic environment that still had enough momentum to withstand financial tightening. Now, that cushion is gone. If another round of inflationary shock emerges, such as food CPI, which typically lags behind an energy shock by three to six months historically, the Fed will face a policy environment with almost no "graceful exit path": continuing to raise rates in a backdrop of only around 2% real consumption growth could directly crush consumers, while staying put and allowing inflation to rise again would be akin to acknowledging being trapped in a "cage."
The Atlanta Fed's GDPNow forecast just dropped below 2%.
Geopolitics
There is an analytical path that only dwells on commodity prices themselves: rising oil prices, increasing input costs, constrained central banks, and slowing growth. For many investment portfolios, this framework is already comprehensive enough. However, it is necessary to acknowledge that energy shocks do not occur in a vacuum.
Over the past two years, the U.S. has systematically tightened the channels through which China acquires low-cost energy, including Iranian oil and Venezuelan oil, resources that used to flow through a "shadow network" at well below market prices. Whether "Operation Epic Fury" has such a strategic consideration or merely accelerated an already ongoing trend is not within my ability to judge. What I can observe is the overall structure surrounding this process.
The reporting around Jared Kushner predominantly focuses on an "ethical narrative": on one hand, he serves as Trump's chief negotiator in the Middle East, and on the other hand, he raises $5 billion from Gulf sovereign wealth funds, funds that come from the governments he is negotiating with.
But compared to ethical issues, I am more concerned with the operational logic reflected in this behavior. Kushner did not act hastily, nor did his team improvise. When the "transactional layer" operates at such a high frequency and intensity in a short period, it often means that there is a clear structural arrangement behind it: this administration is considering military action, economic leverage, and capital flows as interlinked tools within the same system.
In other words, this is not a random operation, but a planned and ongoing sequence of actions.
For the purposes of this article, a more critical point is: this round of oil price shocks is not a random "weather event"; it has its drivers and beneficiaries. This fact will directly affect your judgment of its duration and the policy response.
Recession as a Strategic Vulnerability
The traditional understanding of a recession is economic: output contraction, rising unemployment, central bank intervention. However, the framework used here is different—it incorporates the incentive structure of geopolitics alongside economic logic.
A recession is not just an economic state but a redistribution of negotiating power among nations.
The mechanism is not complex: once a country falls into a recession, its fiscal space, political capital, and external credibility all shrink simultaneously. The government cannot use non-existent resources, and the central bank struggles to normalize policy without exacerbating the contraction. Negotiating counterparts in trade, security, capital markets, and other areas will be aware of this and factor it into their negotiation conditions.
Conversely, countries that can avoid a recession or only "fall into a recession later" are on the other end of the balance: they can dictate rules, attract capital outflows from contracting economies, and accumulate strategic leverage that opponents would otherwise consume to maintain their operations.
This is not a novel insight but the oldest logic in state governance. The peculiarity of the current moment is that this mechanism is operating in a unique environment: the central banks of major importing economies are already constrained by the "cage" we discussed earlier.
In such an environment, the G10 is not a homogeneous entity, but is differentiated by its energy structure. The US, Canada, and Norway are net oil-producing countries. When oil prices rise, their energy sector expands, and the central bank faces an inflation structure that is quite different from other countries. In contrast, Japan, the UK, Germany, France, Italy, and most Eurozone countries are net importers. Every increase in oil prices directly impacts their production costs, trade balance, and overall inflation level. In a world where oil is used as a geopolitical tool, they are essentially the "short energy" side.
This "trap" also has very different outcomes for these two types of countries. For net exporters, even in the face of global stagflation pressure, they can still rely on energy income and related employment to provide a buffer. For net importers, however, they have to endure inflationary shocks without any income hedge. Their central banks are unable to ease (because inflation has not yet subsided) and find it difficult to tighten further (because growth is already weak). Structurally, this constraint on net energy importers is much greater than the constraint on Washington.
Geopolitics, Economics, Central Bank Constraints, and the Incentive Mechanism Running Through Them
At the geopolitical level, the key is not the competition between import economies, but their relationship with the forces benefiting from their weaknesses. A country in recession becomes a more "compliant" trading partner, a less reliable security provider, and is also more likely to be the target of patient, long-term penetrating influence—and China, in particular, is willing to adopt this strategy. China doesn't need to actively "attack" a weakening economy; it just needs to wait, provide financing, lock in supply relationships, and gradually gain structural dependence during the negotiation process as the other party transitions from strength to weakness. Recession is what makes all this possible. Therefore, avoiding recession is not just an economic goal, but a strategic goal. Governments of all net energy import camps actually understand this, even if they may not express it in those terms.
On the economic front, the core incentive is: to "buy time" as much as possible before the growth further deteriorates and forces more disorderly policy responses. Through supply agreements, lock in costs before the next round of inflation data is released; through investment commitments, attract capital that may otherwise flow out due to economic contraction expectations; through trade arrangements, substitute for a price mechanism that has already failed. These measures are not "clean" solutions, but they are all better than another scenario—being forced to the negotiating table in a recession.
At the central bank level, constraints are the most explicit and the most difficult to resolve. Lowering interest rates rashly while inflation has not yet fallen may further solidify inflation, while maintaining the status quo in a situation of ongoing weak growth may trigger a collapse in demand, making the cost of the next round of easing even higher. For net energy-importing countries, the situation is even more complex: their inflation path to some extent depends on the Fed's decisions rather than being entirely driven by domestic policy. With interest rate differentials changing, the local currency fluctuating against the dollar, input inflation adjusts accordingly, such that the looseness of this "policy cage" partly depends on Washington's choices rather than those of Frankfurt, Tokyo, or London.
Considering the above framework holistically, a clear picture emerges: the traditional central bank reaction function has failed, and governments worldwide are using fiscal and diplomatic means to substitute for monetary policy. The resulting capital flows are no longer solely driven by interest rate differentials but depend more on which economies have successfully escaped constraints and which remain trapped. This differentiation, i.e., "who is inside the cage, who has found an exit," is first reflected in the foreign exchange market. The foreign exchange market fundamentally prices a gap: the distance between where policy "should go" and where it is actually allowed to go. And when this gap simultaneously widens among several major importing economies, cross-border capital allocation is no longer a secondary issue but a core one.
Connecting All the Dots
The truly thought-provoking question is not whether a recession will come, but whether the governments and central banks of major importing economies will "allow" a recession to occur. The last time a demand shock of a similar scale opened a window, China seized the opportunity. The recession of 2020 was a key moment for China to cement its global commodity export dominance. This position was not achieved through coercion but because while other countries were busy dealing with the crisis, China was executing a clear strategy.
In the current environment of being in a "policy trap," central banks around the world are acutely aware of this historical period. Therefore, the more critical question is not whether they will continue to hike rates in the face of a supply shock, risking a recession, but whether they will quietly ease the liquidity environment, tolerate financial asset price increases, allow valuation expansion, to avoid the political and strategic costs of enduring an economic contraction.
This equity valuation chart can be seen as one interpretation of this choice. In a sense, the market may already be pricing in this answer.
I believe that once the market reaches a consensus and macro commentators in the media realize they are "seeing the trees but not the forest," the market will experience a severe repricing: first impacting the forex and interest rate markets, then spreading to an aggressive chase for gold and silver. At that point, the central banks' "inaction" will carry more weight than any of their statements at press conferences.
In my view, we are entering the final stage of this macro and geopolitical "endgame."
Tomorrow, Part Two. Foreign exchange and interest rates are precisely the core tools for pricing in the constraints and incentives mentioned above. The implied premiums and discounts in these markets are the most direct signals of which economies global capital believes are "breaking out of the trap" and which remain stuck. Next, we will proceed from here.
