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Today’s Points:

• In Argentina, President Javier Milei’s party (and by extension Trump) won the midterm vote — updates here, analysis tomorrow;
• US inflation data won’t stop the Fed from cutting rates this week;
• But they still gave reasons for concern;
• The USMCA trade pact has more problems than an ad featuring Ronald Reagan;
• The US-China negotiations likely ensure another happy Monday for markets;
• AND: RIP to the other half of Soft Cell

Belated Inflation ...

It looks as if we can be certain that the Federal Reserve will cut the fed funds rate this week. That was the universal conclusion from the delayed inflation report for September, and it’s doubtless correct — even though the headline rose to 3%, the very top of the Fed’s target range. This is how inflation breaks down into its key components, as graphed by Bloomberg’s Economic Analysis function (ECAN <GO> on the terminal):

The big reason for optimism came from rental inflation, whose measurement is controversial as it comes with a long lag because it averages all leases signed over the previous 12 months. The disparity with the private sector indexes that are based only on the last month’s leases, such as Zillow’s, is reducing, and shelter prices dipped far more than expected. That was the main factor keeping the overall number under control:

A range of subtler statistical measures of core inflation showed declines for the month but remained above 3%. This is true of the “supercore” (for services excluding inflation), the trimmed mean (excluding outliers), the median, and for an index of sticky prices which are hard to reduce:

If the Fed was prepared to cut in September despite somewhat elevated core readings, this report offers no reason to desist from a cut this week — although it will need to be careful to avert the growing impression that its true target has now risen to 3%.

If there are problems, they come, inevitably, from tariffs (of which much more is below). The direction of travel for core goods (most directly affected by levies) and food is troubling, even if both still contribute far less to overall inflation than services does:

The trend is concerning. They contribute to a “K-shaped” report with diverging components. Notably, egg inflation, recently a matter of political controversy, has gone negative; but instant coffee inflation has gone ballistic, in large part because of sweeping tariffs on Brazil. 

Overall, Wall Street took the report as an unambiguous positive. The S&P 500 Index closed the week at a record as, for the first time in a month, did Bloomberg’s index of the Magnificent Seven tech stocks — several of which announce earnings in the next few days. They were helped by falling bond yields and rising optimism on inflation. Swaps have signaled for a while that tariffs will cause a one-off bump to inflation, rising next year before subsiding over the next two years — which would be a positive outcome. The one-year swap is now back to lows not seen since Liberation Day, showing great optimism that tariffs will never hurt that much:

Is this right? The imponderable question continues to be whether tariffs will eventually have the big impact on inflation that had been predicted. It’s still too soon to count that out. The economist John Cochrane highlights in his Grumpy Economist blog a conversation with an anonymous retail CEO, who points out that businesses were able to stock up before the tariff pause came to an end on Aug. 1 and are still selling that inventory. That means the effects will be delayed:

We are all raising prices slowly and carefully as the tariffed inventory gets sold (remember, accounting wise, we have a cash hit paying tariffs upon receipt, but we have a P&L hit when we sell the tariffed goods) … There is a major shock to retail and the economy coming … it’s just masked right now because we are selling older inventory, and trying to hold prices for holiday.

This is a believable story and suggests a potential big swing to come next year. Until we can confirm this version of events, expect the rally in risk assets to continue. 

Oh, Canada….

President Donald Trump’s decision to halt trade talks with Canada and impose an additional 10% tariff over an Ontario-backed TV anti-tariff ad featuring Ronald Reagan is only his latest move to upend the traditional rules of trade diplomacy. Trump’s fury shouldn’t surprise anyone who recalls his proposal for Canada to be the 51st state. While the scope of the additional levy is unclear, it builds on the existing 35% base tariff for noncompliant goods under the US-Mexico-Canada Agreement (USMCA).

The setback underscores the difficulties lying in wait for the USMCA’s scheduled review next July. This year’s sharp decline in Canada’s exports to the US has added to the urgency as Ontario resorted to an unconventional approach while Prime Minister Mark Carney engaged Washington — and tried to talk down the provinces. Quarter-on-quarter exports suffered their biggest fall since the pandemic:

The pain for Canada also shows up in central bank policy. Previously intertwined with the US, the Bank of Canada has had to cut much more aggressively than the Fed over the last year, and the gap is only projected to narrow a little next year:

Earlier this year, that didn’t even help by weakening the currency, but the recent revival of the US dollar might begin to help Canadian exporters. A more dovish Fed could mess that up:

It’s possible that trade diplomacy, similar to the latest attempt at an agreement between the US and Beijing, may lead to the reversal of the additional 10% tariff. The bigger question is whether Washington will soften its hardline stance in the USMCA review. George Pollack of Signum Global argues that, unlike the first quarter of this year, the demands the US will likely be making of its neighbors, starting with auto rules of origin revisions, will be too complex for either party to swallow without putting up a fight:

In response, we expect President Trump to turn to tools with real bite, such as, for example: Tariffs on USMCA-compliant goods; Triggering the deal’s 6-month termination clause. And while these threats and measures will be tempting for markets to dismiss as mere negotiating bluster, they may prove too serious to ignore.

Still, the 2,000-page-plus agreement — which succeeded the North American Free Trade Agreement in Trump’s first term — won’t be easy to shutter without devastating consequences. It took nearly two years to put the current agreement together, reflecting the intricate supply chain connections between the three countries. Dismantling it in its current form would be painful for all three countries. Michael McAdoo of Boston Consulting Group sees a range of possible outcomes:

You can imagine a shorter process where they keep that large agreement intact, but do some smaller side agreements or complementary agreements that would cover a sector that concerns the US or the other countries, or a topic like rules of origin for automotive and how to get more North American content in there. That's another scenario that we're looking at.

With Canada barely escaping a technical recession this year, the reality that it’s tied too tightly to the US is beginning to draw a reconsideration. More than 75% of Canada’s exports go to the US. China has done a great job of finding alternative customers, and Carney is already looking to the East for new trade partners, specifically China and India. The aim is to double non-US exports over the next decade. That target looks ambitious, as exports to both countries have been roughly stable for the last decade. Canada can’t increase its trade as easily as China has: 

Interdependence cuts both ways. About 60% of America’s crude imports and 85% of its electricity imports come from Canada. Ottawa is aware of its economic importance, even as it recognizes the strain that any pivot away from the US would impose. 

The same logic extends to Mexico. As Bloomberg Opinion’s Juan Pablo Spinetto notes, geography remains its most significant advantage. Mexico now accounts for nearly 16% of US imports, up from less than 13% when Trump first took office in 2017, and it has surpassed China as America’s top trading partner. Whatever the new terms, Spinetto argues, Mexico will remain more attractive than many other US suppliers. And if Trump’s White House is serious about reviving American industry, it cannot do so without Mexico, whose younger workforce, lower costs and cultural proximity remain essential to that goal. In that sense, Trump’s America First agenda depends on its neighbors succeeding. Which is a point Ronald Reagan might have made.

— Richard Abbey

Tariffs for the Gipper

So, what exactly did Ronald Reagan say about tariffs? His library has a video of the entire five-minute address that you can view here. If nothing else, it’s a reminder that the man was one of the greatest political communicators who ever lived.

Ontario’s ad can be viewed here. If you watch it straight after the original, it seems like a fair summary and certainly captures its spirit. Reagan didn’t like tariffs. But the library says it was misleading. Canada’s national broadcaster compares the two here. The ad does what anyone would do when condensing down from five minutes to one: rearranges and takes the best lines. It’s obviously a work of advocacy — and rams home that the current Republican Party has split from Reagan’s legacy. Even in a world where CBS agreed to pay $16 million to Trump over the way 60 Minutes edited an interview with Kamala Harris, it still seems a fair and legitimate point.

However, it was likely to provoke Trump, and the rest of the world has decided over the last six months that it’s a good idea not to do that. The fallout of the last few days bears this out. China and the US evidently want to back down from their latest trade spat without giving up their greatest sources of leverage — China’s dominance of rare earths and US control of semiconductors needed for AI. We can assume that the Gipper won’t be called in to support Chinese positions any time soon. 

Survival Tips

Rest in peace, Dave Ball. By far the less famous half of the synth-pop duo Soft Cell passed away last week at the untimely age of 66. He and the extremely camp front man Marc Almond are known for 1981’s mega-hit “Tainted Love,” still unavoidable on mainstream radio, but there was more to them than that. Known as one-hit wonders in the US, at home in the UK they had a series of hits including at least two over-the-top masterpieces — “Say Hello, Wave Goodbye” and “Torch” — that rank with “Tainted Love.” After Soft Cell, Dave Ball stayed at the cutting edge in The Grid, which produced some great music for raves later in the 1980s. Ball’s music has endured and it was great in his time. Have a great week everyone.

More From Bloomberg Opinion

• The 1920s Immigration Mistake America May Repeat: Stephen Mihm 
• A Ukraine Peace Deal Must Include Three Guarantees: James Stavridis
• Good-But-Not-Great Inflation Data Should Keep the Fed Cautious: Jonathan Levin

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