The possibility has been mentioned frequently on the pages of this report but to claim that ‘we have told you so’ would be intellectual dishonesty. For most, wars are incomprehensible in the 21st century, yet as the global order is being rewritten it is becoming an acceptable method to establish one’s authority. Despite, or maybe because of, its growing international isolation, Israel has struck Iran’s nuclear capabilities and its military facilities killing two of its top commanders. No doubt, the genie was let out of the bottle after the horrifying Hamas attack on Israeli civilians in October 2023 and the latest atrocity comes at a time when Iran is at its most vulnerable as its proxies, Hamas, Hezbollah, and the Houthis are close to obliteration or under constant pressure.

It is possibly the most severe escalation of the Middle East conflict since the 1973-1974 oil embargo but this time the US claims to have no involvement in the strikes. Beyond the inevitable human tragedy, from the economic perspective, it is the last thing the world and the US need. Inflation has been contained, and the job market has proven resilient. Now with oil prices rallying overnight 13% at one point and Brent volume already over 1 million contracts at 6 am London time, the silly question is what’s next? Answering it is impossible, only a list of possible events can be drawn up. Iran pledged to retaliate but is it capable of effectively doing so and if it is, will it also target US bases? Will regional oil supply and transport routes, namely the Strait of Hormuz, which 20 million bbls of oil sails through a day, be affected? Will the US and Western powers intervene to de-escalate? Will regional Arab powers get involved? There are many questions without satisfactory answers, therefore it would take a bold man to bet on the reversal of the overnight price jump ahead of the weekend.

Unpredictability Compounded

Financial markets have been weathering the trade tension impressively. The MSCI All-Country stock index reached a new record high yesterday, in the US the tech-heavy Nasdaq Index rallied 34% from the post-Liberation Day low, and the 10-year Treasury bond yield, although comparatively high, has been failing to challenge the early-April peak of 4.6%. Perhaps the dollar is the only asset class that signals some caution as its index against its six major peers fell to a fresh 3-year low yesterday. There have been widespread downward revisions of global and regional economic growth estimates, but US hard data, whilst not exactly sanguine, does not insinuate financial Apocalypse for now. Inflation has not spiked yet, unemployment is steady, and the budget deficit has narrowed. Yet, regardless of how it is dressed up and sold, trade tariffs will most plausibly be reciprocally introduced between the US and its trading partners, including China, only the extent of them is dubious. Although it will lead to deteriorating economic conditions, the recent data set justifies the current optimism, notwithstanding the impending uncertainty.

The other major source of precariousness is the OBBBA, the One Big Beautiful Bill Act, which is basically the US budget. The legislation was narrowly passed in the House of Representatives in May and is now in front of the Senate, which will approve it or change some of its provisions before it is signed into law by the President. The bill includes the extension of the 2017 individual income tax breaks and temporarily adds new ones, worth approximately a combined $3.75 trillion. Overtime hours and tips would not be liable for tax and the bill would also allow Americans to deduct interest on car loans. The child tax credit would be increased and the government's debt ceiling raised.

The loss of revenue would be partially compensated by import tariffs and by a significant reduction, $1.3 trillion to be precise, in federal spending, chiefly through Medicaid, but the military and border enforcement would see increases. Around 7.4 million people would no longer be covered by health insurance. The bill is obviously contentious and even Donald Trump’s former ‘First Buddy’, Elon Musk, called it a disgusting abomination, while hard-line Republicans are pushing for deeper cuts in government spending. By any means, the non-partisan Congressional Budget Office estimates that the legislation will cost around $2.4 trillion for the US taxpayer and elevate the national debt to around $36.2 trillion. The Committee for a Responsible Budget believes that the cost could be as high as $3 trillion over the next 10 years when interest rate payments are accounted for or $5 trillion if temporary tax cuts are made permanent. Considering these projections, it is no surprise that rating agency Moody’s downgraded US credit worthiness.

As far as investment in the US is concerned the most controversial part of the bill is Section 899, aka ‘revenge tax’. It can be deemed a retaliatory tax on countries that impose ‘unfair’ taxes on US companies. It would allow the US to levy taxes capped at 20%. The ‘unfair tax’ category is a broad definition and Section 899 would also include the so-called base erosion and anti-abuse tax which is aimed at preventing foreign companies operating in the US from shifting profits abroad. Companies from the EU, Canada, Australia, the UK and South Korea would be impacted. According to the Joint Committee on Taxation, Section 899, if enacted, could raise as much as $116 billion over 10 years. On the other hand, because of its punitive nature, it would adversely affect foreign investment, accelerate divestment, and hit equity markets, especially dividend-paying stocks. Trust in the US government would further erode. If one accepts that credit is the economic equivalent or embodiment of trust, then bond yields could go further higher at the time when $9.2 trillion US Treasuries are maturing this year. It is one-third of the total outstanding debt and close to 30% of the US GDP. Refinancing it at a higher rate will have serious economic repercussions, hence the pressure from the White House on the Fed to cut rates by a full point. Oil, or the US energy dominance, on the other hand, could be ‘ravaged’ by Section 899, as eloquently put by a Reuters columnist, since foreign energy companies might re-think their investment strategies in the world’s biggest oil producer. Markets like certainty and calculability, which are the very antitheses of the incumbent Administration.

Overnight Pricing