Pelagia imports oil worth 4% of GDP and runs a current account deficit of 2% of GDP. Oil prices rise 30%. What happens to the deficit, the currency and the rates market, and what trade would you put on?

The deficit widens from 2.0% to about 3.2% of GDP, the mark comes under pressure first, and the rates market starts to price hikes. Pelagia now needs another 1.2% of GDP of foreign money each year to pay for the same oil. The currency is where that pressure shows fastest, so the cleanest expression is short the mark against the dollar, sized knowing the position costs about 2.5% a year in carry.

A family whose petrol bill jumps has to find the extra money somewhere: savings, a loan, or spending less on other things. A country is the same. Pelagia must buy dollars to pay for oil, so a higher oil bill means more marks sold for dollars every day, and unless new foreign money arrives to meet that selling, the mark falls. The current account deficitThe amount by which a country’s payments abroad for imports, interest and dividends exceed what it earns abroad; it must be financed by foreign money flowing in. is the gap Pelagia has to finance from abroad. At 4% of GDP, a 30% rise in the oil price adds 1.2% of GDP to it, taking it from 2.0% to 3.2%.

The central bank has two tools against a falling currency: sell its dollar reserves, or raise rates so that holding marks pays more. Oil also feeds straight into inflation through fuel and transport costs. Both routes push the rates market to price hikes at the short end, so two-year yields rise more than ten-year yields and the curve flattens. If the central bank chooses to let the currency take the strain, import prices lift inflation instead, and the hikes come later rather than sooner; either way, short-dated rates are pulled up.

Short the mark against the dollar. The currency is the first market the extra dollar demand reaches, it is liquid, and the trade does not depend on guessing what the central bank chooses. The cost is carry: holding a short in a currency that pays 6.5% against one that pays 4% costs about 2.5% a year, roughly 0.6% a quarter. The mark has to fall by more than that over your holding period just to break even. Paying two-year rates is the second-choice trade: it pays if the central bank hikes, but it loses if the bank defends the mark with reserves instead and leaves rates alone.

Three things. The move may already be in the price: if the mark fell 4% in the week of the shock, the easy part of the trade is gone, and you need a view on how much more the wider deficit costs. Demand may respond: if oil volumes fall 5% as prices bite, the deficit reaches 2.9% rather than 3.2%. And foreign investors may keep buying Pelagian bonds if the central bank hikes early and hard, financing the wider gap without the currency moving. Set the stop where the thesis is disproved rather than where the loss starts to hurt: if the mark strengthens while oil stays high, the financing story is winning and the trade is wrong.