Wars are complex adaptive systems, shaped by political, military, economic, technological, and human factors. As such, their outcomes are inherently unpredictable. Look no further than the Middle East or Ukraine. Or, after the weekend's events, the Middle East and Ukraine.

Despite Friday's sell-off, oil prices ended the week higher, while the structure of the two major crude oil contracts strengthened significantly as reciprocal attacks intensified around the Persian Gulf. The escalation stemmed from differing interpretations of the Memorandum of Understanding, particularly regarding control of the Strait of Hormuz, signed by the US and Iran on 17 June. Tension rose further a week ago, when the Houthis declared a naval blockade in the Red Sea, casting doubt on the viability of the Bab el-Mandab Strait as an alternative shipping route. Fears of supply disruptions and, with prices jumping last week, possibly demand destruction, will persist.

Yet the weekend in the Persian Gulf was relatively calm. Signs of renewed diplomatic efforts, particularly by Oman, to restart negotiations prompted both sides to lay down their weapons, at least for now, with Iran pledging to halt its attacks as long as the US suspended its strikes on Iran—a pause that has now lasted three days. This potentially temporary truce is undoubtedly a welcome development. The market’s gut reaction is a substantial overnight sell-off, although Saudi oil installations along the Red Sea coast came under Houthi attack.

To pour more fuel on the Middle East fire, Ukraine, according to the Iranian Foreign Ministry, attacked an Iranian merchant vessel in the Caspian Sea, killing one sailor. Add to that Ukraine's accusation that Russia has shared satellite imagery of Gulf states and US military facilities in the region with Iran, together with the frequent incursions of Russian drones into Romanian airspace, and no one could be blamed for concluding that any truce, ceasefire, or armistice may prove illusory.
 

Re-igniting Trade Wars

Amid the geopolitical upheaval in the Middle East, the US Administration has found the time and appetite to refocus its efforts on reducing the country's trade deficit by resorting to its conventional method of imposing tariffs on trading partners. Even before the Supreme Court ruled that the International Emergency Economic Powers Act does not authorise the President to impose tariffs unilaterally, punitive import taxes had already proved about as invigorating for the US economy and the trade deficit as a mammoth dose of horse tranquilliser. As a rule of thumb, import tariffs tend not to reduce trade imbalances because they appreciate the country's currency (in this case, the dollar), increase input costs, reduce export competitiveness, and fail to address the fundamental cause of the imbalance: the gap between domestic investment and national savings. The US trade deficit widened to $77.6 billion in May, the second largest since Liberation Day. According to the Bureau of Economic Analysis, for the whole of 2025, the value of US imports of goods and services exceeded that of exports by $901.5 billion, a decrease of just 0.2%, or $2.1 billion, from 2024, well within the margin of error.
 
Although import taxes do not appear to meaningfully reduce trade deficits or support the US manufacturing sector, the Administration imposed another round of these punitive measures last week. As the previous 10% global tariff regime, introduced under a law that temporarily authorised the Treasury to collect such duties, expired on Friday, the latest measures, ranging from 10% to 12.5%, invoke the 'forced labour' provision of the Trade Act of 1974 to justify the move. Whether one regards this as a well-founded policy or merely a legal subterfuge depends largely on one's political affiliation and personal convictions. Nevertheless, we are all aware of how workers are abused and exploited in countries such as the UK, Australia, Japan, and, not least, the EU. In addition to these blanket tariffs, Canada and Brazil must now also contend with import duties of 50% and 25%, respectively, on selected goods exported to the US.

Whether these new measures will achieve their intended objectives is dubious, at best. One unintended consequence of this increasingly stringent trade regime, however, may be a deterioration in the US fiscal position. US public debt, measured as a percentage of GDP, has been rising steadily for the better part of the past 40 years, interrupted only by occasional and short-lived periods of improvement. Public debt stood at around 30% of GDP in the early 1980s, gradually climbed above 100% by late 2012, and is forecast to reach 123% this year. Among the G7 economies, only Japan (210%) and Italy (140%) have higher debt-to-GDP ratios than the US.
   
Public debt and the trade deficit are inextricably linked through the 'Twin Deficits' theory. At times, budget deficits directly contribute to trade deficits. The government's need to finance its borrowing by issuing Treasury securities pushes interest rates higher to attract investors. As US borrowing costs rise, foreign capital flows into the country, strengthening the dollar, making US exports more expensive, and ultimately widening the trade deficit.
  
Trade deficits can also have a profound impact on public debt. A trade deficit, where imports exceed exports, effectively creates a surplus of dollars held abroad. These dollars are then recycled back into the US economy as foreign central banks and exporters purchase US government debt to preserve the value of their dollar holdings. For the US government, this represents a relatively inexpensive means of financing persistent budget deficits.
 
The point is that, because the two are joined at the hip, neither is likely to narrow significantly. There is no imminent danger of the US falling off a fiscal cliff; economists generally believe that persistently rising budget deficits can be managed for another 10 to 20 years. In the meantime, however, servicing the national debt will become increasingly expensive, fiscal flexibility will diminish, private investment will be crowded out, economic growth will suffer, and the cost of everyday living will continue to rise under inflationary pressure. In light of current international conflicts, trade and budget deficits may not rank among the foremost concerns of economic policymakers and market participants. Nevertheless, they do nothing to mitigate the harmful consequences of persistent deficits and an ever-growing debt burden. On the contrary, they only exacerbate them.

Overnight Pricing