Oil prices trim early losses as Iran supply fears overshadow Russia measures
Here is the key variable every macro investor should pay attention to now.
The chart below shows the percentage of the population living in countries that are net importers of energy.
It’s absolutely impressive to see how North America has turned the ship around on energy dependence by actually becoming a net energy exporter, but we can’t say the same for many other places around the world.
At the top of the list, we find Asia and Europe - pretty much everyone living in these continents resides in a country that needs to import energy from around the world.
Why does it matter?
Europe’s LNG dependency and Japan/Korea oil dependency from countries that rely on Hormuz to deliver energy to them means the marginal cost for energy goes up dramatically for European and Asian households and firms.
For their currencies, this is something called a Terms of Trade shock.
Basically, the amount of EUR and JPY necessary to keep importing the same volumes of energy goes up fast while on the other hand of the ledger the value of Japanese and European exports doesn’t increase.
The net result is that the European and Japanese currencies need to depreciate to keep things in balance - a classic Terms of Trade shock for their currencies.
A cheaper currency while inflation is at or above target risks inflation expectations increasing further.
That means bond investors will require an additional premium to own European and Asian bonds, adding fiscal strains to current account balance and currency strains.
Will things unfold this way?
It all depends on how long the terms of trade shock lasts.
Do you think we will see a prolonged war with further upside for energy prices, or we will get a quick resolution and normalization in markets?
***
This article was originally published on The Macro Compass. Come join this vibrant community of macro investors, asset allocators and hedge funds - check out which subscription tier suits you the most using this link.