What could a U.S.-China trade deal mean for investors?

Strategic competition between the U.S. and China is of critical importance to geopolitics, the global economy, and markets.

What should investors be watching over the near term and the longer term as the U.S.-China relationship evolves?

How long could the U.S.-China trade détente last?

Trade tensions between the two countries have cooled somewhat in the months since the unilateral import duties imposed by the U.S. on Chinese goods led to a rapidly escalating exchange of tit-for-tat tariffs between the two nations.

• De-escalation: China and the U.S. have walked back or paused the extreme tariffs that they had threatened to impose.
• Ongoing dialogue: Bilateral talks between cabinet members from both countries have followed.
• Acts of goodwill: The U.S. took steps to reduce restrictions on access to chip design software, for example, while China resumed export licensing for critical minerals on a limited basis.

The roller coaster of news flow related to the Trump administration’s trade policies hasn’t slowed, from agreements with some countries to the possibility of additional U.S. tariffs for others. Amid these twists and turns, markets have welcomed the apparent détente between the U.S. and China on trade matters.

“...markets have welcomed the apparent détente between the U.S. and China on trade matters.”

The situation remains highly fluid. However, planned in-person discussions between President Trump and President Xi Jinping—the first of which is slated to take place this fall at the Asia-Pacific Economic Cooperation Summit—could have a moderating effect on U.S. policy actions related to China.

Highly important meetings with a highly variable range of outcomes

The results of these expected meetings between President Xi and President Trump are indeterminable at this juncture.

Markets would likely react favorably to a trade agreement that builds upon the “Phase One” deal that the two countries inked during President Trump’s first term in the White House.

Terms of that agreement, signed in January 2020, included a commitment from China to expand its imports of U.S. goods and services by USD 200 billion from 2017 levels. The market’s reaction would be even more positive if a deal were to lower the effective U.S. tariff rate on imports from China.

At the same time, investors must consider the possibility that the talks could go poorly, leading to a tariff increase.

Here are some areas to watch in the run-up to a possible meeting between the two leaders.

1. Diplomacy: The cadence of cabinet-level discussions between the U.S. and China and surrounding news flow over the coming months could provide insights into the meetings’ tenor.
2. U.S. economy: Incoming data could shape the conversation. It will be important to gauge the extent to which higher effective tariff rates translate into higher inflation or economic weakness in the near term.

I am also monitoring legal challenges to the Trump administration’s so-called reciprocal tariffs and import levies that ostensibly aimed to pressure targeted countries into curbing fentanyl trafficking.

However, even if the Supreme Court were to strike down these tariffs as unlawful (not a given), the Trump administration could replicate them using other authorities, albeit with some limitations.

Focus on the structural issues at the heart of U.S.-China economic competition

A trade agreement with China, were it to materialize, is unlikely to resolve the complex sticking points shaping U.S. policy over the medium to longer term.

Both Democratic and Republican lawmakers increasingly view economic policy through the lens of strategic competition with China, with an emphasis on national security and gaining an innovation edge.

1. Shoring up U.S. industry

Supply chain disruptions during the pandemic called attention to the vulnerabilities created by decades of globalization.

Temporary Chinese export restrictions on critical minerals earlier this year underscored this point. China’s dominant position in mining and processing rare earth elements and other minerals critical to modern industry meant that these curtailments halted work or led to near stoppages at some auto factories and other production facilities.

“The Trump administration has deployed various sticks and carrots as it tries to incentivize the expensive and time-consuming process of onshoring of strategic industries.”

The Trump administration has deployed various sticks and carrots as it tries to incentivize the expensive and time-consuming process of onshoring of strategic industries.

For example, the threat of high tariffs on semiconductors and pharmaceuticals appears to be designed to encourage the buildout of production capacity in the U.S. Meanwhile, tax changes passed earlier this year could help to spur business investment in plants, equipment, and research and development.

In the case of critical minerals, the federal government even took an equity stake in a U.S.-based miner focused on rare earth metals and signed a long-term agreement to purchase its output at prices above current levels. These unusual actions highlight the challenge and the perceived strategic importance of resolving this bottleneck.

2. Innovation leadership

Lawmakers in Washington view technology leadership, including advanced artificial intelligence (AI), as critical to national security and U.S. economic competitiveness with China.

This theme arguably runs through much of the major trade and economic policies that the U.S. has pursued over the past half decade.

Recall the first Trump administration’s push to limit China-based telecom equipment company Huawei’s access to critical components from the U.S. Refer also to the Biden administration’s restrictions on exports of advanced semiconductors and chipmaking equipment to China.

We could see the current Trump administration roll out additional policies that seek to give the U.S. a leg up in AI and other areas of rapid innovation, such as biopharma.

Investing in a dynamic policy and geopolitical environment

An expansion and broadening of capital spending could be a tailwind for parts of the industrials sector. At the same time, these investments and higher input costs from tariffs could add to inflationary pressures or weigh on some companies’ profit margins.

Bottom line: A deep understanding of individual companies and industries will be critical to assessing the investment risks and opportunities that emerge as the U.S. and China jockey for an economic edge.