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U.S.-China trade war 90-day truce

Market response

May 12, 2025 | 5 min read
Seema Shah
Chief Global Strategist
Christian Floro, CFA, CMT
Market Strategist
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What happened?

This morning, the U.S. and China announced that they will temporarily lower tariffs on each other's exports, with the U.S. reducing its tariffs on China from 145% to 30% (10% reciprocal tariff plus 20% fentanyl-related tariff) and China reducing its tariff rate from 125% to 10%. These reductions will be maintained for 90 days, giving both sides time to work toward a broader agreement.

Further details are yet to be announced, and there is elevated uncertainty around what could follow the 90-day pause. Nevertheless, the announcement substantially reduces the near-term pressure on the U.S. and Chinese economies and represents a significant de-escalation of trade tensions.

Market reaction

The agreement has delivered a major upside surprise to markets. At the end of last week, President Trump had commented that an “80% tariff on China sounded about right” and, as a result, analysts were hoping for a drop in U.S. import tariffs to 60% at best.

Risk assets have responded very positively. Both U.S. and Asian markets are surging, and the good news is reverberating across global markets with European markets also rising on the day. Oil prices have bounced and the U.S. dollar has strengthened sharply, while the euro has weakened back to 1.10 against the dollar. In addition, gold has fallen, the VIX index has dropped below 20 for the first time since March 27, and U.S. Treasury yields have risen sharply as investors back away from the safety trade.

Moving forward

U.S. economy
The 30% tariff on China’s exports is still much higher than tariffs on other countries and is still higher than at the turn of this year. But this is undoubtedly a very positive development for both the U.S. and China. In recent weeks, with daily data showing a collapse in container traffic from China to the U.S., there were growing concerns of empty shelves in U.S. stores. Today’s news should enable a resumption of U.S./China trade, averting the worst-case scenario of lasting Covid-like shortages for consumers and firms.

Beyond that immediate positive impact, there should also be a meaningful drop in expectations for a U.S. recession. Indeed, of all the trade deals, this is the one that really matters for the U.S. economy. The 145% tariff on China would have represented a 19% effective tariff increase by itself, likely reducing U.S. growth by just over 2%, taking the U.S. economy dangerously close to recession. With Chinese tariffs at 30%, the tariff rate is still elevated but it brings down the overall U.S. average tariff rate to around 12%, indicating a much smaller negative impact on the economy of just over 1%.

We noted in our April 10 market response ‘A 90-day tariff reprieve’ that “a more substantial decline in recession risk would likely require a meaningful walk-back of the extreme tariffs on China.” The walk-back in tariffs has likely been delivered. That said, there is still likely to be some economic scarring because of shelved investment plans and the hit to both consumer and business sentiment. What’s more, trade with China is still more expensive than it was six weeks ago, suggesting a sustained negative impact on consumer spending power and/or company profit margins. Furthermore, with details on a broader trade deal still scant and some risk that tariffs are pushed back up at the end of the 90-day period, trade policy is still a moving target.

There remains a high degree of uncertainty, which could continue to weigh on investment and hiring decisions. As such, a slowdown in economic activity is still likely over the coming months. Larger firms are likely to be better positioned to weather the storm given their bigger balance sheets, which can absorb swings in inventory, and their more diverse supply chain network, which affords flexibility in the face of trade barriers.

China
For China, the announcement is equally significant. Our calculations had suggested that—without any re-routing of China’s goods via other economies—the impact to China’s economic growth would have been quite severe, amounting to a GDP drag of about 3%. With today’s news, providing it is not reversed, China’s economy should feel a meaningfully lighter impact, with the expected GDP hit amounting to less than 1%. Moreover, China will likely increase exports to the U.S. over the next 90 days to maximize on the reprieve. Policymakers will also feel less pressure to provide additional stimulus.

U.S. average effective tariff rate and projections
1900–present

U.S. average effective tariff rate and projections from 1900–present in graph form
Source: Bloomberg, Principal Asset Management. Data as of May 12, 2025.

Market outlook

Today’s announcement confirms that peak pessimism is firmly in the rear-view mirror. There remains some potential for disappointment and markets should not be complacent about the risks, especially as additional sectoral tariffs are potentially forthcoming for pharmaceuticals and semiconductors. Indeed, despite the recent corrective turns on trade policy, the direction of travel implies more, rather than less, trade barriers compared to a year ago.

But the key takeaway for investors from today’s announcement is that while the Trump administration wanted to restructure the global trading system, it did not mean to implement a de facto trade embargo that led to the wholesale decoupling between the U.S. and China. The implication is that the worst-case scenario has been averted and, providing the scarring to the U.S. economy of the past two months is not too deep, the economy should not be confronting a recession this year.

Moreover, with tax policy moving forward and Treasury Secretary Bessent dedicating more time of late to speak about the promise of greater deregulation in the months ahead, growth friendly measures should also provide a boost to the U.S. outlook.

A key question will be whether the discussions around an end to U.S. exceptionalism now come to a halt. Certainly, if the U.S. is not looking to redraw trade lines at the expense of near-term U.S. economic strength, there should be renewed confidence in the U.S. as an investment destination. But with global economies now galvanized to boost their economic foundations, global diversification is a more pertinent discussion than ever before. Specifically, in the case of Europe, a shift away from fiscal austerity and a consideration of the benefits of deregulation should raise its long-term economic profile. Longer-term, the broader question of the credibility of the U.S. and institutions is unlikely to disappear.

Most fundamentally, today’s announcement is an important reminder to investors to stay invested. Trying to time the market—and time policy announcements—is an impossible task and risks missing out on significant gains. Market pullbacks are not unusual—on average, the U.S. stock market experiences an intra-year decline of 13.5%, yet most years still end with gains of around 9%. Volatility is a normal feature of investing, not a flaw—those who remain disciplined and invested through the noise are often rewarded over time.
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Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results.

Views and opinions expressed are accurate as of the date of this communication and are subject to change without notice. This material may contain ‘forward-looking’ information that is not purely historical in nature and may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information in the article should not be construed as investment advice or a recommendation for the purchase or sale of any security. The general information it contains does not take account of any investor’s investment objectives, particular needs, or financial situation.

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