Merlin Weekly Macro: Trump, Putin setbacks heighten geopolitical risk

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“It’s my party and I’ll cry if I want to”

Who would be a warlord? Some of the tough guys are finding it an even tougher gig. A belligerent President Trump, the self-proclaimed President of Peace, has almost zero aptitude for it; never entirely sure of his destination but having taken a decidedly wrong turn on his military “diversion” to Iran, he finds himself up a cul-de-sac where the road behind him has also closed. He is in a stalemate that he is struggling to break; it was not supposed to be like this.

President Putin, KGB colonel (“there is no such thing as an ex-KGB agent”) and war-monger-in-chief, is faring even less well: not only has his Special Operation in Ukraine bogged and stagnated, but he is also rapidly discovering that being on the defensive with the Motherland under regular aerial bombardment is as uncomfortable as it is embarrassing and frustrating; he is in a stalemate he is finding it impossible to break; it was not supposed to be like this.

The latest twists and turns of World War Three

Even if the concept seems remote and divorced from everyday experience for almost all except those on whom the missiles are directly falling, virtual World War Three is with us and is marching on relentlessly. It is expanding and becoming more convoluted and contorted.

As if we need reminding: whether as belligerents or directly supplying military and financial aid and intelligence, the Russo-Ukrainian war involves not only those two countries but Iran and North Korea pitted against the 32 members of NATO (some much less willingly than others, despite Russia actively and provocatively pushing the boundaries and testing NATO’s readiness on land, in the air and at sea); Japan, Australia and others are supporting Ukraine. China and India are aiding and abetting Russia. The Middle Eastern conflict extends from the Levant to the Gulf. Taken together, apart from Turkey, active conflict is a reality in an almost unbroken line from the Baltic Sea to the Indian Ocean. The one possible bright spot is Trump’s “Board of Peace” brokering a potential peace solution in Gaza (given their deep mutual mistrust and long-standing  animosity, whether what is palatable to Hamas is as agreeable to Israel remains to be seen).

The comedian who came in from the cold 

But things are moving on. While the four-year long conflict in Ukraine itself has stagnated geographically, Ukraine is actively and successfully taking the war to Russia. It is building a remarkable record of attacking major infrastructure and energy installations (including all 11 of Russia’s biggest refineries) deep inside the Russian homeland; as well as attacks on Moscow, drones have successfully hit targets as wide-ranging as St Petersburg on the Baltic coast in the Russian north-west and as recently as July 6th as far east as Omsk in central Russia (Omsk hosts Russia’s biggest refinery producing 22 million tonnes a year; to give an idea of location and distance, Omsk lies on the same longitude as Bombay, it is on the same latitude as Glasgow; it is 1,550 miles from the nearest extremity of the Ukrainian border, as far as Moscow is from London as the crow flies).

In a major geo-political shift for the current administration, President Zelensky has been rehabilitated by Donald Trump. Trump’s allegiances are transactional, fluid and fickle; whether this change of heart has duration is a moot point. Nevertheless, after the beasting Zelensky received at the hands of Trump and JD Vance 18 months ago in the notorious White House ambush, the transformation is remarkable. Trump’s worm has turned. Apparently impressed with success, he wants to be associated with it. Zelensky is successful, ergo ride his coat tail. It’s amazing how the mid-terms focus the mind and change perspectives.

There are two major elements to Zelensky’s advantage. First, with bi-partisan support, Congress will almost certainly approve the new “Lindsey O. Graham Sanctioning Russia and Iran Act of 2026”; the bill targets individuals, corporations and countries who have assets, investments, business or trade with the US that have any association with Russian and Iranian oil and gas. This would include both China and India being in line for financial sanctions and tariffs. Sanctions have so far been largely ineffective, but this latest development sends a signal to all members of the Axis of Disruption and others that the US will take financial action against them if they buy blood energy. The second is that Trump is open to licensing the manufacture of Patriot air defence missile systems to Ukraine so it can make them locally (Trump remains politically unwilling directly to support Ukraine militarily; an additional pragmatic factor is that the US is running very low on stocks because of their extensive use in the Gulf and Ukraine).

Climacterics in the Gulf

But this week has also seen new, unwelcome developments in the Gulf conflict as Tehran continues to give Trump the runaround. The leadership is goading him. Iran has returned to attacking US assets in the Gulf States and has resumed attacks on shipping in the Straits of Hormuz. But in a new phase of escalation, it has also targeted US bases in Jordan and, through its Houthi proxy in Yemen, allegedly attacked a US owned gas tanker berthed at an Egyptian port on the Mediterranean coast close to the Suez Canal.

Whether fact or mischief being added to spice up an already volatile brew, Ukrainian intelligence claims that Iranian attacks targeting US assets are being actively helped by Russian-supplied satellite intelligence providing details of their locations. It further conflates the Middle Eastern and Ukrainian wars. It implies payment in kind: Russian reciprocity to Tehran in Iran’s own regional conflict in return for Iran’s long-standing supply of drones to Moscow for use against Ukraine.

Trump is no diplomat; nobody could aggrandise him with that term. However, his negotiation of the Abraham Accords at the end of his first term was arguably his finest act of genuine diplomacy: reconciling deep-seated factional differences between the UAE, Bahrain and Israel; it was always his intention to bring in Saudi, Syria and Lebanon (it is widely presumed that Iran’s October 2023 attack on the Israeli Kibbutzim was attributed to Tehran’s alarm at the coagulation of this geo-political realignment and its own growing isolation).

Therefore, one final geostrategic development in our fast-moving story is this week’s revelation of Trump’s determination that among the Middle Eastern states, Saudi Arabia should become the major regional stabiliser in the post-oil era: in a wide-ranging strategic support package, the US is willing to entertain supplying Saudi with the wherewithal to develop a nuclear energy programme for the production of electricity.

The US and Israel are trying to prevent Iran having a weapons grade nuclear capability; Israel, Pakistan and India are all nuclear states with varying degrees of capability; it would be logical that in time Saudi takes a decisive step towards its own nuclear weapons programme. Saudi has every right to defend itself on equal terms. However, a potential proliferation of nuclear-armed states at the fulcrum of the Eurasian landmass, the most fragile and febrile region on earth and demonstrably critical to the world economy, should give us all pause for thought. Surely policing that should be the future focus of Trump’s Board of Peace.

Market reactions

What do markets make of all this? The oil price simply rolls with the punches: it goes down when a US-Iranian ceasefire is effective and it rises when the missiles are flying again. However, the surprise factor behind new military flare-ups is less pronounced as time goes on and, while still volatile, the price peaks are lower than at the beginning of the conflict. That is likely to remain the pattern until something new happens that moves the fear dial beyond the red zone; we will discuss the possibilities later (as an indication but certainly not a forecast, the Brent futures market shows forward oil contract prices remaining in the mid-$70s this time next year).

In fixed income it is the effect on inflation that continues to drive investor concerns. Not so much anxiety that there is a repeat of the post-Covid/Biden reflation trade/Russian gas supply manipulation triple whammy that hit the world economy in the 2021-2022 period and pushed inflation into double figures for the first time in a generation; this time the discomfort is that the disruption to the supply side of the economy caused by the various conflicts goes on longer than markets expect and mitigating actions take longer to effect. The risk is that inflation gets stuck for longer at levels above the 2% target rate common to the Federal Reserve, the Bank of England, the European Central Bank and the Bank of Japan while in too many cases economic activity remains sluggish and below capacity. Sovereign bond yields remain volatile, correlating with inflation sentiment linked directly to the oil price.

For the fifth policy meeting in a row, the Bank of England opted to keep interest rates on hold at 3.75%; the vote was split 6:3 in favour of keeping the status quo over those who wanted a quarter point rise. While the June inflation rate eased to 2.6%, the Bank expects it to rise before the year-end (“the MPC judged that the risk of strong inflationary pressures was greater than the risk of weak inflationary pressures”), largely due to energy costs including the third quarter 13% increase in the domestic energy price cap effective from July 1st. If higher rates remain a possibility, the Bank is reluctant to raise them to mitigate against the inflation risk created by an exogenous shock, in an economy that is persistently struggling to grow. 

Noting that there has been effective policy tightening applicable to households and businesses, the Bank admitted that the bond markets have been doing its job for it without the Bank’s own Base Rate having to be changed. Sniffing out changes in risk (even if condensed through the narrow lens of inflation), the steepening and rising yield curve has kept upward pressure on such areas as mortgage and car financing costs, both of which are typically priced off two- and five-year gilt yields (against the Bank’s Base Rate of 3.75%, the two-year gilt currently has a yield of 4.32%, while the five-year is priced at 4.51%; the day before Trump went to war-- sorry, sorry, before Trump went on a “diversion”, must get that right—with Iran on February 28th, those two and five year gilt yields were 3.55% and 3.74% respectively while the Base Rate was already 3.75%). Corporate bond yields also remain elevated.

Crystal ball gazing

But let’s finish by taking this analysis back to the beginning in which we said both Trump and Putin are finding it tough extracting themselves from invidious positions of their own making. Let’s speculate about what surprises there might be around the corner. 

Trump faces the US mid-terms in only three months and one week; the omens are not good for him. 12 months ago, the average retail price of a gallon of gasoline (petrol) in America was $3.13; today the average is $4.08, exactly 30% higher, thanks entirely to Donald Trump’s foreign policy. Four bucks a gallon is a political killer, especially for a President who promised, he promised faithfully, to bring down the cost of living. The odds are he will do something directly to address the situation (either by a major military escalation with Iran, or the opposite, defusing it for political expediency but potentially cutting a “bad deal” that effectively empowers and legitimises the Iranian regime), or he intervenes elsewhere to deflect attention away from domestic US fuel costs. Any and all potentially open up new avenues of geopolitical risk.

As for Putin, his popularity has taken a hammering recently. He is acutely sensitive to his personal approval ratings. As at mid-July, 67% of Russians approved of him as president, while 23% disapproved; 12 months ago, 87% supported him while only 11% were against. History says 60% approval is the minimum he will tolerate; on the last two occasions it fell that low (January 2014, and January 2022) he immediately did something dramatic in response. He invaded Crimea in February 2014, and he invaded Ukraine in February 2022. It is not helpful to Europe’s security that Donald Trump is undertaking a complete review of US force numbers stationed in Europe and has already started a significant reduction: would Putin risk another attack, if not against a NATO country, perhaps on Moldova or Georgia? 

Hopefully neither Trump nor Putin will play the game of joining the dots. However, it would be unwise to discount either or both doing something brazenly performative to pull their political irons out of the fire, something that might have far-reaching consequences for everyone else.

Best keep the tin hat and the slide rule close at hand. 

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