The missing pieces to the Federal Reserve's inflation puzzle

US trade deals with China, Canada and Mexico remain elusive, even as central bank signals rate cuts are coming

Canada currently faces a 35 per cent tariff on goods imported into the US. AFP

The US Federal Reserve is signalling it is prepared to cut interest rates next month, but the central bank faces significant uncertainty as US trade deals with its three largest trading partners remain elusive.

Those deals centre on trade disputes that started in the first months of President Donald Trump's second term in office: China, Canada and Mexico.

In 2024, total US trade with China totalled about $658.9 billion, while it totalled $909.1 billion with Canada, and $935.1 billion with Mexico, according to the Office of the US Trade Representative.

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While Mr Trump has touted trade framework agreements with major exporters including the European Union and India, deadlines for the US's three largest trading partners continue to be pushed back.

“The biggest issue for the Fed is going to be how are US companies going to deal with this,” said Arnim Holzer, global macro strategist at Easterly EAB.

“Are they going to save margins and fire employees? Are they going to allow margins to deteriorate and maybe not impact employment so much?”

Cross-border trade

US trade with its northern and southern neighbours has grown increasingly interconnected. Canada exported more than 75 per cent of its goods to the US last year, while Mexico exports about 80 per cent of its goods there.

Both Mexico and Canada have been hit with heavy tariffs tied to Mr Trump’s dissatisfaction with border security and drug trafficking, and both are operating under separate 90-day tariff deadlines with little clarity on how they will be resolved.

Canadian Prime Minister Mark Carney last week announced that he would be dropping many of the country's retaliatory tariffs, matching US exemptions for goods under the USMCA, in an apparent effort to restart trade talks with Washington.

Canada and US debate tariffs at CERAWeek

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“We are working on something. We want to be very good to Canada,” Mr Trump said after his Canadian counterpart dropped the retaliatory measures.

Mexico is also seeking to placate Mr Trump by raising tariffs on China as part of its 2026 budget proposal in September, Bloomberg reported on Thursday.

Meanwhile, businesses are rushing to claim exemptions under the United States-Mexico-Canada Agreement (USMCA) to avoid the 35 per cent tariff rate for Canada and the 25 per cent rate for Mexico. An analysis from Fitch ratings in August showed 81 per cent of goods imported from Canada were USMCA compliant in June, up from 56 per cent in May. Similarly 77 per cent of goods from Mexico met USMA requirements that month, up from 42 per cent the month prior.

The USMCA is up for review in 2026.

China

The Trump administration has also set back tariff implementation on China by an additional 90 days, pushing back the new deadline until mid-November. The extension came after talks between negotiators from Washington and Beijing in Stockholm last month.

The world's two economic superpowers had engaged in tit-for-tat escalatory tariffs on each other's imports.

Shipping containers at the Port of Los Angeles in Los Angeles, California, US, on Friday, April 4, 2025. Bloomberg

Mr Trump had increased tariffs on Chinese imports to 145 per cent, and China had retaliated with a 125 per cent tariff. The US and China have since drawn back those tariffs to 30 and 10 per cent, respectively.

Still early days

This comes as Fed chair Jerome Powell raises greater concern for the labour market – the other side of central bank's dual mandate – than price stability.

“I think it's unlikely we're going to see certainty here in the short- to medium-term as [Mr Powell] considers a policy change,” said one geopolitical analyst.

Mr Powell suggested that tariffs could lead to a one-time increase in prices, although he said it is still early on in the process.

“It will continue to take time for tariff increases to work their way through supply chains and distribution networks,” he said during his Jackson Hole Symposium address in Wyoming last week.

Inflation data released on August 29 showed that core goods prices were unchanged in July versus June. Separate data released earlier in August showed that price pressures were beginning to appear in imported goods such as household furnishing.

On Thursday, Fed governor Christopher Waller said he is hearing “some rumblings” from the business community that they cannot continue to wait on the sidelines amid this uncertain tariff policy. Businesses had been postponing investment because of that uncertainty, he said.

“We could see … investment projects that were postponed begin to pick up, which would be positive for the economy. But how employment decisions evolve is more up in the air,” he said at the Economic Club of Miami.