Commerzbank’s Michael Pfister revisits international trade theory to explain why higher Oil prices and the US status as a net Oil exporter are supportive for the Dollar against the Euro. He argues that improved US terms of trade, slower price adjustment and central bank inflation targets mean the nominal EUR/USD exchange rate bears most of the adjustment, with scope for a rebound if Oil prices fall.
Oil shock and Dollar trade advantage
“It is likely that there will be agreement on the fact that the US is now a net oil exporter, while the euro area has to import oil on a net basis. If the price of oil rises, then, all other things being equal, the US’s terms of trade will also rise, i.e. US export prices will rise relative to those in the euro area.”
“If US export prices rise relative to those in the euro area, Americans suddenly have more money at their disposal as Europeans ultimately pay more for the US oil they need.”
“Ultimately, the real exchange rate consists of two components: the price level ratio and the nominal exchange rate.”
“In theory, both factors could be the reason for the adjustment. In most Western countries, however, the central bank tries to stabilise price increases at a certain level. Price changes are also made very slowly, of course. This basically means that the nominal exchange rate is likely to appreciate to restore the system to a new equilibrium.”
“I would guess that the terms of trade effect is the main reason for the strong appreciation of the US dollar. The fact that the US is now a net oil exporter also indirectly means that energy-intensive industries in the US are likely to be more protected than those in Europe, and growth is therefore more resilient.”
“The decisive factor, of course, is how long-term the oil price increase is. Exchange rates adjust much more quickly than prices and have therefore already reflected the change in terms of trade. If the conflict ends sooner than expected and the price increase is not sustainable, however, the effect will quickly reverse.”
“In other words, we would see significantly higher EUR-USD levels again.”
(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)
Source: https://www.fxstreet.com/news/eur-usd-oil-driven-terms-of-trade-support-dollar-commerzbank-202603050753
