Investing.com -- Higher oil prices are emerging as a central risk variable for the U.S. economy, with the balance between inflation and growth being determined by the conflict in the Middle East, Morgan Stanley acknowledged in a note to clients on Friday.

Analysts led by Michael Gapen said the near-term outlook hinges on whether rising energy costs begin to curb demand rather than simply lift inflation.

“Oil price shocks create convexities and nonlinearities,” Morgan Stanley wrote, warning that moderate price gains tend to “push inflation higher and dampen activity,” while sharper increases may “destroy demand such that growth effects dominate.”

Morgan Stanley is monitoring several indicators to determine when the balance tips. Retail spending is the first critical gauge.

The bank noted that oil shocks “tend to reduce consumer spending on goods over services,” adding that the impact should appear in weaker retail sales excluding gasoline. However, the key March report will not be released until April 21.

Labour data so far remain resilient. Morgan Stanley expects March headline payrolls to rise by 60,000 and private payrolls by 70,000, saying initial jobless claims “do not suggest layoffs have picked up.”

Business confidence is another pressure point. The bank highlighted that a deterioration in sentiment tracked by the NFIB would matter, as “uncertainty shocks reduce payroll growth the further NFIB confidence is below 100.”

Financial markets may provide the earliest signal. The bank said inflation-linked securities such as TIPS could act as a “high-frequency indicator on views about demand destruction,” particularly if oil prices continue to rise.