EXECUTIVE SUMMARY
Welcome back. It’s been six weeks since our last note at the end of July. While we have a lot of ground to cover since we last wrote, all pivotal moments and policy have been thoroughly tracked and factor into today’s note, though we lean heavily on where things are at the present moment rather than detailed analysis of the steps along the way. The full memo is attached and below are the shortened toplines.
From a topline economic perspective, the war with Iran is no longer simply about crude, but rather refining and chokepoints, with the end result being a real-time re-mapping of global supply chains. Saudi Arabia now has no export route that avoids a contested waterway. Houthi forces hold the port of Mokha and a set of Red Sea islands commanding the southern approach, the Jizan refinery complex has been struck twice, and the East-West pipeline that allowed the Kingdom to bypass Hormuz was hit and will be out of service for weeks. Riyadh has told OPEC its output is the lowest since 1990. And with Brent above $108, American diesel has set an all-time record of $6.31 a gallon (regular unleaded is hovering at $4.30).
At home, that shock has arrived in the price index and resulting household borrowing costs. August CPI held at 3.4% with gasoline alone responsible for better than a third of the monthly increase, wholesale goods prices jumped 1.1% in a single month, and wage growth came in at 3.1%. That last figure marks the fifth consecutive month in which prices have risen faster than pay, which helps explain a labor print on Friday of 162,000 jobs but the University of Michigan consumer sentiment gauge near its lowest recorded level. Those Americans who are working, yet getting poorer, are driving sentiment down despite an unfazed equity market. The borrowing side contributes, as well, with the 10-year Treasury back at 5%, its highest since July 2007, and the 30-year mortgage above 7%.
USMCA negotiations have been thrust into the spotlight following the August breakdown of talks with Canada. Dueling narratives have placed the blame around a variety of sticking points (e.g., trucks, third-party agreements, etc.), but the outcome remains regardless. Talks collapsed on August 21 and 50% duties via the 1930 Smoot-Hawley trade act are now firmly in place. Canada answered in kind on September 8, blowing past the next possible negotiating window. The Trump Administration, of course, responded and threatened to bar Bombardier from the American market, ordered Canadian goods be stripped from federal procurement schedules, and proclaimed an all-encompassing import ban. The last piece is the most important, both from its sheer scope, but also for the new window it creates, setting up a September 29 effective date. Canadian provinces are now retaliating on their own, demonstrating Prime Minister Mark Carney’s potential difficulty in gaining unanimity for any future agreement (the same dynamic that potentially led to the end of talks in August). USMCA, of course, is not dead. Last week, Commerce Secretary Howard Lutnick flew to Mexico City to discuss relief on autos and metals. All signs continue to point towards progress south of the border, despite the negotiating freeze to the north.
Our final item is the AI race, which we have given its own section for the first time given its continued elevation in the news and wide-reaching impact over trade agreements, supply chains, foreign investment, and possibly humanity itself. The last ten days produced an extraordinary sequence: the heads of the leading American labs publicly asked to be slowed down, a researcher resigned in protest, Congress responded from both parties, the President called the whole thing a hoax, and global technology stocks sold off. Underneath the noise sits a drafted executive order that would have created a pre-deployment review body, now all but off the table.
THE FIVE TAKEAWAYS
TAKEAWAY 1: Real incomes have now fallen for five straight months. Corporate profits took 18% of national income against labor’s 60%, the widest split since 1945, while wage growth of 3.1% ran behind 3.4% inflation. Consumer sentiment sits near a record low with respondents naming fuel prices and tariffs. That is the defining issue of the midterms. For their part, Republicans will seek to expand the issue set by tying Democratic candidates to the rising Democratic Socialists of America (DSA) movement.
TAKEAWAY 2: Saudi Arabia has lost both of its export routes and oil will remain elevated. The Kingdom shifted crude west to avoid Hormuz, pumping the East-West pipeline to its capacity. The Houthis have since taken Mokha, seized Red Sea islands, struck Jizan twice, and materially damaged the Saudi’s most important lifeline: its terrestrial pipeline. Output at a 1990 low is a logistics and security problem rather than a reservoir one, and it is why a Hormuz agreement—whether tomorrow or well into the future—will likely not immediately lower American pump prices, most especially before the midterms.
TAKEAWAY 3: Everything Canada has absorbed so far came from a presidential order covering only 5% of its exports. Washington has since found a fourth instrument in procurement exclusion, which requires no tariff authority and is difficult to litigate. Ottawa’s provinces have adopted the same tool, but their leverage is a fraction from an economic perspective. Prime Minister Mark Carney’s mission to align the middle powers will not restore the leverage balance before September 28, the next cliff. With USTR Ambassador Jamieson Greer affirming that the Administration’s last offer was indeed its last and final offer, Carney has few good immediate options beyond rising Canadian nationalism.
TAKEAWAY 4: The long end of the yield curve repriced across five sovereign markets at once. Britain paid its highest gilt yield since 1998, French thirty-years reached a 2008 high, Bunds a 2011 high, and the Japanese ten-year touched 3% for the first time this century. No one central bank is immune to the rising cost of borrowing, yet demand remains strong. The recent British sale drew twenty times its size. That said, borrowers are beginning to wade into the Chinese offering where yields remain low, making corporate borrowing more attractive. As countries ramp back their U.S. Treasury holdings, all eyes are on tomorrow’s consequential Bank of Japan rate decision.
TAKEAWAY 5: Industry is clamoring for a government-imposed AI development slowdown but congressional Republican Leadership is resisting the pressure campaign and the Administration and its industry allies are outright ridiculing the request. The Administration’s position, held by some notable industry players (Jensen Huang, David Sacks) is that a slowdown would disproportionately benefit the largest companies, while throttling innovation and risking a self-inflicted disadvantage in the existential AI race against China. Drawing on the experience of the global warming debate of the last twenty years—and resulting policy and rulemaking—China is unlikely to play by the same rules as the West. Against that backdrop, a drafted executive order this summer would have created a review body but is now all but off the table.
WHAT MOVED THIS WEEK
THE FED: The FOMC raised rates a quarter point Wednesday to 3.75-4.00% in a unanimous vote, the first hike since July 2023, with 16 of 18 dots pointing to another this year. Warsh told reporters the job is not finished. The 10-year touched 5.04% Tuesday, its highest since July 2007, and the Dow fell 600 points on the central bank’s decision.
CANADA: 50% Section 338 duties took effect September 15 on a broad list of goods; outright import bans on alcohol, dairy, and motorcycles follow September 29. Washington has added Bombardier and federal procurement exclusion to the toolkit, and New Brunswick will answer on October 1. Both leaders are signaling openness while neither has moved on substance.
BRUSSELS: Von der Leyen offered Canada associate membership in the EU from the podium Wednesday with Carney in the front row. Trump responded by threatening “very serious tariffs” if he deems the push a hostile act. Germany and France remain immovable on cherry-picking and Ottawa itself is now raising sovereignty questions.
ENERGY: Diesel hit $6.31 nationally and retail gas will remain elevated through the election. Gulf-Iran talks on Hormuz collapsed before they began when Bahrain withdrew. Ongoing Houthi attacks on Saudi Arabia infrastructure bring into question the Kingdom’s defense security agreement with other Gulf states, most notably a nuclear-armed Pakistan.
ARTIFICIAL INTELLIGENCE: Despite the doomsday hyperbole of humanity’s demise over the last week, little has changed in Washington. The House passed legislation codifying the Administration’s Ratepayer Protection Pledge, but its prospects prior to the election are unlikely in the Senate. Meanwhile, the House is now gone until November 9. The next best lawmaking opportunity around AI safety or limiting China will come in the year-end NDAA during lame duck. Expectations, however, should remain low.
VENEZUELA: The Administration’s annual drug determination this week lifted Venezuela’s “failed-demonstrably” designation, citing the interim government. Meanwhile, further oil and gas investments are being considered by Harold Hamm’s Continental and ExxonMobil, possibly joining Chevron’s already-announced $7 billion infusion.
KEY DATES: NEAR-TERM
- SEPT 20: German state elections in Mecklenburg-Western Pomerania and Berlin
- SEPT 21-24: UNGA high-level debate; UK Prime Minister Andy Burnham’s first meeting with President Trump expected
- SEPT 24: Chinese President Xi Jinping’s White House state visit
- SEPT 29: American import bans on Canadian alcohol, dairy, and motorcycles take effect
- SEPT 30: Government funding expires; G20 trade ministerial through October 1
- OCT (TBD): Section 301 overcapacity and Section 232 semiconductor determinations expected
- OCT 1: New Brunswick’s ban on American goods in provincial contracts takes effect
- OCT 4: Brazil general election (runoff October 25)
- OCT 5: Québec provincial election
- OCT 11-13: World Health Summit, Berlin
- OCT 12-14: AUSA Annual Meeting, Washington, D.C.
- OCT 12-18: IMF/World Bank Annual Meetings, Bangkok
- OCT 15: G20 Finance Ministers and Central Bank Governors Meeting
- OCT 19: Alberta vote to begin constitutional process toward separation
- OCT 27: Israel legislative elections
- OCT 28: FOMC
- OCT 29-30: EU-Canada summit in Montreal
- OCT 30-31: G20 Foreign Ministers’ Meeting, Atlanta (hosted by Secretary Rubio)
- NOV 3: U.S. midterms
OUTLOOK / ANALYSIS
The robust August jobs print and the Fed’s rate decision now made, the central bank has unequivocally announced that it will fully turn its attention to the congressional inflation mandate. Chair Warsh had already ranked prices above employment at Jackson Hole and the data now backs him up. The Bank of Japan’s decision tomorrow will be closely watched for U.S. bond market implications with the yen at its strongest level of the year and a ten-year JGB at 3%. If the BoJ raises and capital continues to repatriate to Tokyo, the Treasury buyback program may very well accelerate.
On the geopolitical front, Tehran has all but lost control of the strait from a commercial perspective. Talks with Oman are again nowhere and the domestic Iranian economy faces inflation above 80%. Washington’s economic escalation is tightening. Although Secretary Bessent’s “D Day” has only publicly produced action against one Egyptian bank and now VTB, he may very well not need to add Chinese firms to his list as the overall effort is largely achieving its goals. The caveat is the satellite imagery episode, which may act as a predicate for Treasury moving against the PRC. The only available bargain at the moment on Iran is strait security in return for port relief. We are now in a long squeeze period. As such, U.S. prices (particularly diesel) will not meaningfully subside on the back of the Fed’s rate decision. The affordability issue will remain front and center for voters heading into midterms.
The trade agenda has morphed for a global reciprocal negotiation to a Canadian-specific tariff war. The next inflection point comes on September 29, providing a new negotiating window for Washington and Ottawa. Both leaders are signaling openness but the redlines (i.e., trucks) remain. That makes the Prime Minister’s calculation the most difficult. Canadian nationalism is what drove him into office and any concession he makes risks upending his political future not to mention questioning whether he can deliver given the effective veto each provincial premier wields. Québec votes October 5 with a separatist party leading. Alberta votes October 19, with a referendum process still up in the air. Those dates notably sit just after September 29 and will immediately factor into voters’ minds. Meanwhile, Carney continues to pursue the nascent middle powers option. Von der Leyen invited Canada to become the European Union’s first associate member and Ottawa is reportedly exploring an arrangement that would let Canadians live and work in Europe without visas. The details of that alliance will matter both for the U.S./EU ART and for any chance that the U.S. and Canda reach a deal.
All of the above leads us back to the picture at home. Real incomes have fallen for five months, both unleaded and diesel are now at record levels, the 30-year mortgage rate has passed 7%, and profits are taking their largest share of national income since 1945. The segment of the economy with the best outlook—the AI buildout—is now being threatened from within. Leading executives are openly asking for regulation to slow their growth (motives notwithstanding) and the state and local backlash to data center siting continues to build. What makes this picture exceedingly interesting is the President’s response. He knowingly chose to go to war with Iran in an election year, driving the price of energy up. Further fueling the inflation problem, the President remains undeterred on executing his tariff agenda, escalating with Canada and on the cusp of releasing a Section 301 overcapacity finding and a Section 232 semiconductor finding. And finally, he shows no signs of throttling the AI advancement, staking out positions on data centers and regulation that are at odds with public opinion. Some may call that politically nonsensical. But others may call it principled. We only say that it’s a fascinating moment in American political history. The President may very well be inviting a Democratic majority in the House next Congress and is seemingly unfazed and undeterred by the prospect; sticking to his proverbial guns instead.