Will The Economy Face ‘Demand Destruction’ Test?

Key Takeaways

• Rising energy prices from geopolitical tensions could weaken consumer spending.
• Inflation pressures are easing, but consumer spending may slow as savings shrink and wages stagnate.

A resilient U.S. consumer has kept the economy afloat the last few years, but momentum could stall if Iran peace talks falter and the war sparks more inflation, analysts say.

It’s a phenomenon economists call "demand destruction"—when prices are so high that people spend less. Downbeat consumers may hold off on buying a new car, skip a vacation, cook at home rather than dine out or cut down on luxuries.

All combined, the hit to consumer demand would weaken economic growth—perhaps so much that the U.S. economy tips into a recession or approaches one, analysts say.

"It could be very serious, especially if the Strait of Hormuz remains closed for quite a while more," said Tuan Nguyen, an economist at the accounting firm RSM US LLP, referring to the critical chokepoint where a fifth of the world’s oil supply travels.

Why This Matters

Consumer spending has been the backbone of U.S. economic growth. If higher energy costs erode household purchasing power, inflation could persist and recession risks could rise for consumers and investors alike.

Any worries would dissipate if the Iran war ends soon and oil and other commodity markets are mended, Nguyen said. But the economy would take a bigger hit if the disruptions persist, with lower-income consumers at risk of feeling a bigger squeeze, he added.

"We are living in a K-shaped economy," Nguyen said. "Because of that, demand destruction is not going to hit everybody the same way, or even at the same time."

Optimism, for Now

Thus far, the economy has remained on track. U.S. employers added 172,000 jobs in May, and consumers haven’t pulled back too much despite ultra-weak confidence surveys.

Airline executives say travelers are booking flights even if they’re pricier. Consumers are still buying Starbucks lattes and Chipotle bowls.

There are signs of shifting priorities, with Home Depot cautioning that homeowners are delaying big-ticket home improvement projects. But with jobs still growing, consumers "still have the capacity to spend" even if some trim non-essential spending, wrote Richard de Chazal, macro analyst at William Blair.

"If the war continues, however, and energy supplies start to become unavailable even at high prices, demand destruction will start to set in and confidence will have further to fall," he wrote. "But for now, they are still hanging in there."

There are signs that the worst of the inflation pressures are ending, too. Inflation is at its highest pace since 2023, but the May data showed few broad-based pressures beyond energy prices. Average U.S. gasoline prices have fallen from $4.5 a gallon in mid-May to $4.15 earlier this week.

That’s largely because oil traders are optimistic that peace is near, with the global Brent crude oil benchmark now hovering near $90 a barrel. That’s quite a bit higher than the $60 mark at the start of the year, but below the roughly $120 peak when Iran-U.S. tensions were at their highest.

However, oil prices could reach $150 if the Iran war heats up again, according to Jorge León, head of geopolitical analysis at the research firm Rystad Energy. Hostilities resumed earlier this week before simmering again on Thursday, with U.S. President Donald Trump calling off another round of air strikes and indicating a peace deal was near.

"The next few days will be critical in determining whether diplomacy can reassert itself or whether the conflict moves into a more sustained escalation cycle," León wrote.

Smaller Buffers Today

Strong consumer spending helped the U.S. economy weather a similar challenge in 2022, when inflation rose to decades-high levels, partly due to the Russia-Ukraine war disrupting food and energy markets.

Inflation hit an eye-popping annual rate of 9.1% in 2022, which makes the 4.2% increase this May seem mild.

But demand was scorchingly hot in 2022, leaving room for some destruction. Consumer spending on services rose sharply as the pandemic eased, helped by pandemic-era savings, low interest rates and leftover stimulus. A revival in restaurant spending, Taylor Swift tickets and travel all helped prove widespread fears of a recession wrong.

"Back then, demand was so strong that we didn’t have the demand destruction problem," RSM’s Nguyen said, but there’s "a smaller margin for error now."

GDP growth has been relatively sluggish, he noted, and it’s increasingly driven by investments in data centers and artificial intelligence rather than consumer spending.

Weaker wage growth and slimmer savings buffers could also make it harder for consumers to keep up, according to Vail Hartman, U.S. rates strategist at BMO Capital Markets.

RELATED EDUCATION

[Understanding Demand Destruction: Causes and Effects

](https://www.investopedia.com/demand-destruction-5222107) [Consumer Spending's Role in Economic Performance and GDP

](https://www.investopedia.com/terms/c/consumer-spending.asp)

Markets appear to have a “rather optimistic view” about consumers’ ability to withstand another round of inflationary pressures, Hartman wrote. But that sunny outlook may be misguided.

"The erosion of consumers’ real purchasing power has left us wary of a slowdown in consumer spending later this year, if not in the coming months," Hartman wrote.

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