As tensions between Iran and Israel escalate to open confrontation, the United States finds itself drawn deeper into a volatile regional conflict with domestic and global repercussions. The bombing campaign, which answered an open question regarding US engagement, and the Iranian response today, marks a dramatic increase in tensions but appears to pave the way for de-escalation in the near-term. In our view, what began as limited military engagement has expanded into a broader foreign policy challenge—one that threatens to reshape Washington’s legislative agenda, fiscal priorities, and geopolitical posture.

One Big Beautiful Bill Act:

At home, the One Big Beautiful Bill Act (OBBBA) continues to advance through Congress, with Senate Republicans aiming to pass their version by July 4th. Revisions to the House-passed bill were expected, particularly around contentious issues such as Medicaid, clean energy tax credits, and deficit reduction. However, recent U.S. airstrikes on Iran’s nuclear infrastructure have introduced new uncertainties. Some lawmakers may push for increased defense spending in response, while others could demand offsetting cuts elsewhere. The dynamic echoes 2003, when Republicans advanced tax legislation through reconciliation amid the U.S. invasion of Iraq. Though the Bush administration was pushing a large tax cut package heading into 2003, the invasion of Iraq intensified concerns over rising federal spending, military costs, and oil prices, ultimately leading to tax cuts half the size as originally proposed.  

NATO Summit & Defense Spending:

Against this backdrop, the upcoming NATO summit (June 24–25) takes on heightened significance as allies reassess the alliance’s role amid escalating regional instability and shifting global security priorities. NATO members are expected to endorse a new defense spending target of 5% of GDP—a sharp increase from the current 2% benchmark and aligned with President Trump’s demands. However, the proposal is not without controversy: Spain has publicly opted out, citing concerns over domestic budget pressures. Meanwhile, Trump is pushing for an exemption for the United States, arguing that its current defense outlay—approximately 3.4% of GDP—is already sufficient and should not be subject to the new threshold. The NATO summit is being held two weeks before the 90-day reciprocal tariff moratorium expires, adding further economic pressure to the discussions.

Strait of Hormuz & Outlook for Oil:

Meanwhile, fears of disruption in the Strait of Hormuz—through which roughly 20% of the world’s oil supply flows—have begun to reverberate through energy markets. Although a full closure remains unlikely due to Iran’s economic dependence on oil exports and the likelihood of a severe military response, even the possibility of disruption is enough to drive volatility. If a closure were to take place, oil prices would spike above $100, increasing the risk of stagflation. US producers are unlikely to increase production in the near term given the heightened uncertainties, including the risk of OPEC+ increasing production. We would expect an increase in oil price due to a supply shock to negatively affect US net GDP given the increase in inflation.  

Fed Policy & Rates:

Recent developments further complicate the calculus for the Federal Reserve as it weighs Fed policy decisions in the midst of inflation ‘risks’ and a slowing economy. Upside risks to inflation remain, with higher tariff rates ahead and tail risks related to energy prices. However, these risks have not yet materialized and economic data continues to indicate below trend domestic economic growth. Reduced stimulus via the OBBBA would further weaken the outlook. We note, and find reasonable, the market re-pricing the December 2025 Fed Funds contract with a rising probability of 75 basis points of cumulative cuts by year-end. The path to that end is uncertain and likely to be uncomfortable for Chair Powell with increased political pressure likely ahead of the July FOMC meeting. 

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