As investors continue to grapple with the fallout from President Trump’s “Liberation Day” and await potential trade deals, the ongoing US-China standoff remains a daunting backdrop. What began as a tariff war has transformed into a far-reaching global economic rebalancing, encompassing not just trade, but technology, finance, and national security. Both nations are racing to form coalitions to counter the other's influence. The old capitalist mantra of maximizing efficiency has been replaced by a focus on self-sufficiency, leaving investors to navigate a fog of uncertainty. Who will blink first, and how should investors position themselves in this shifting world order?
Assessing the Damage
High tariffs have effectively created a de facto embargo. Research by the Cato Institute suggests that current tariff rates surpass the optimal thresholds of the Laffer Curve, which relates tax rates to resulting levels of tax revenue collected by a government. Their analysis concludes that current tariffs are likely to impede trade and reduce government revenue rather than increase it.1
For China, deep integration into global supply chains makes decoupling complex and costly. Early signs indicate significant damage. Reciprocal tariffs of up to 145% have led to a sharp decline in US-China trade. According to Morgan Stanley, container bookings from China to the US have dropped by 64% in just two weeks, with freight rates and shipping volumes continuing to fall.2 China's New Export Orders Purchasing Manager Index (PMI) saw its largest drop since February 2023, signaling deepening distress. Consumer sentiment is weakening, with anxiety over jobs and income rising. Despite government stimulus, sales of cars and home appliances are slowing.
Meanwhile, the US economy is more resilient, but it is not immune. Higher tariffs on Chinese imports have raised costs for American manufacturers and consumers, particularly in electronics and automobiles. Inflation is creeping up due to the passthrough of tariffs, and retailers like Walmart warn of empty shelves due to disrupted supply chains. Meanwhile, US farmers and exporters face declining demand for agricultural products and energy shipments due to retaliatory Chinese tariffs. Pricing in growing stagflation or recession risk, US equity, bond, and currency markets all sold off initially, with recovery later in the month. Subsequently, the US economy is showing early signs of strain due to negative wealth effects, with investment slowing and growth expectations declining due to significant policy uncertainty. The battle has evolved into a game of attrition, with neither side likely to back down although both sides have indicated they are open to talks. A US recession in the second half of 2025 now seems increasingly probable.
China’s Policy Response
China's response has been reactive as policymakers have opted to wait it out, believing time is on their side along with more room for larger policy response. However, initial policies were designed to buffer moderate tariff increases, not the severe measures now in place. Achieving the 5% gross domestic product (GDP) growth target appears very challenging under current conditions. Diversification of export destinations also has become more difficult due to global backlash against Chinese goods, prompting tariff hikes from other nations.
In the short term, China is focusing on stabilizing employment through retraining, tax relief, and unemployment benefits rather than pursuing pure growth. Efforts to boost domestic consumption will include supporting the stock and property markets to mitigate the negative wealth effect. Over the long term, China is likely to focus on structural reforms to release household savings, bolster the private sector, and increase services consumption.
China's fiscal response remains cautious, prioritizing fast-tracking government bond issuance and expanding trade-in programs. The government may reduce the reserve requirement ratio (RRR) and policy rates, but it is unlikely to launch aggressive stimulus programs. The focus will be on maintaining stability and promoting high-quality development.
Who Will Blink First?
The overarching objectives of the Trump administration’s tariff strategy remain unclear to many, perhaps even to China. Further complicating the ongoing impasse is the deeply embedded economic interdependence between the two nations. China manufactures roughly three times as many goods as the US, and the US remains heavily reliant on Chinese exports and some key natural resources. Notably, 90% of microwaves, 80% of smartphones, 75% of children's toys, and 66% of laptops in the US are made in China. 3 This heavy dependency and complexity of global supply chains make the decoupling and US manufacturing onshoring very challenging (see Exhibit 1).
China, which is more exposed due to its export dependency and financial imbalances, can stabilize its economy and markets through more stimulus and tighter government interventions. The US, with its high innovation, more flexible markets, and lower export reliance, is structurally stronger, but political pressures for quick results and from shorter election cycles are mounting. Both sides are seeking off-ramps, with China potentially exempting some US goods from tariffs and the US considering lowering some tariffs while delaying others, such as on certain electronics.
Investment Implications
In this volatile environment, haven assets are in short supply. Chinese government bonds (CGBs) offer attractive real yields (see Exhibit 2) and currency-hedged return potential, especially as the People’s Bank of China (PBOC) eases monetary policy. With trade headwinds mounting, China may allow a gradual depreciation of the renminbi (RMB) against the China Foreign Exchange Trade System (CFETS) basket to support exporters without triggering capital flight (see Exhibit 3).
Meanwhile, long-end US Treasury bonds face three key risks: higher inflation, fiscal pressure, and term premiums. US equities and other risk assets could be negatively impacted by elevated interest rate volatility. As global investors recalibrate the haven status of US assets, we may see more structural weakness for the US dollar, which bodes well for certain commodities and real assets that historically benefit from a weaker greenback.
Emerging markets, like India, Brazil, and some ASEAN countries, could benefit from the ongoing US-China conflict, particularly as investors reconsider their overweight exposures to US assets and the dollar. These nations may offer attractive investment opportunities, especially in global bonds and currencies, which could shine until a global recession takes hold.
Conclusion
The US-China standoff is not just a short-term tariff dispute; it is a long-term, strategic battle with profound geopolitical and economic consequences. Both economies face significant challenges. Most recently, each side has appeared to make overtures toward initiating discussions, which suggests they recognize the magnitude of what is at stake. While Chinese policymakers have refrained from public statements, China may be looking to begin exempting some US products, including pharmaceuticals and industrial chemicals, from tariffs. The US also rescinded some tariffs on Chinese goods, including smartphones and some electronics. These exemptions of hard-to-replace goods roughly mirror one another and are likely aimed at alleviating some of the immediate fallout in each country’s domestic economy. Regarding next steps, the US has signaled that it wants to begin trade discussions, and China appears to be evaluating these requests.
Until some resolution is attained, China will remain under pressure from export reliance, weak domestic demand, and property market drag. The US will be constrained by inflation, a dire fiscal situation, and political uncertainty. Investors should prepare for continued volatility and policy-driven surprises.
References
- “High Protective Tariffs Have Been Short-Lived in American History,” by Joseph Bishop-Henchman, April 8, 2025, Cato at Liberty.
- “Tariff Shock Starts to Bite,” Robin Xing, April 24, 2025, Morgan Stanley Research.
- “The Chinese goods Americans most rely on, from microwaves to Barbies,” Sam Joiner, et al, April 12, 2025, The Financial Times.
Index Definitions
The Purchasing Managers’ Index (PMI) is an economic indicator of the prevailing direction of a country’s economic trends in the manufacturing and service sectors. It is a diffusion index that summarizes whether market conditions are expanding, staying the same, or contracting by surveying senior purchasing executives at private sector companies.
The CFETS RMB Index is published on a weekly basis. The Index mainly refers to China Foreign Exchange Trade System (CFETS) currency basket, including the foreign currencies listed and directly trading against RMB CFETS. The sample currency weight is calculated by international trade weight with adjustments of re-export trade factors. The sample currency value refers to the daily CNY Central Parity Rate and CNY reference rate. The baseline date is 31 December 31, 2014. The baseline index value is 100 points.
Tracy Chen, CFA, CAIA
Portfolio Manager
Key Takeaways:
- In the US-China tariff war, neither side appears willing to concede, creating uncertainty for investors.
- Research shows high current tariff levels are likely to reduce trade and government revenue.
- China’s deep integration into global supply chains makes decoupling complex and costly. Early signs indicate significant damage from tariffs.
- While more resilient, the US economy faces rising prices, especially in electronics and automobiles, and reduced demand for agricultural products and energy shipments. A recession seems likely.
- China's limited policy response has been focused on employment and domestic consumption. However, it can stabilize its economy and markets through more stimulus and tighter government interventions.
- The US is structurally stronger but political pressures are mounting.
- Chinese government bonds offer attractive real yields and currency-hedged return potential.
- Other select emerging markets could benefit, particularly as investors reconsider exposures to US assets and a weaker dollar.
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