SUMMARY
We consider the outlook for Chinese growth this year and which equity sectors may see stronger performance.
KEY TAKEAWAYS:
A new US-China trade deal would be beneficial for both sides, but faces many hurdles
Stimulus can help cushion the trade blow to China’s economic growth this year
China is not likely to rush into a deal, especially one that leaves it much worse off than before
Any potential trade deal is likely to bring further strength to the Chinese yuan
We see potential in domestic consumption and AI-development related equity sectors
After the escalation, the de-escalation. Global investors breathed a sigh of relief after the US and China agreed to dial down trade tensions on May 12 – at least for now.
The world’s two leading economies are each lowering tariff rates on each other’s goods by 115% for 90 days. US tariffs on Chinese imports thus come down to 30% and Chinese tariffs on US imports fall to 10%.
This is a better outcome than many observers had thought likely. Going into the talks, a rate of 50-60% had seemed on the cards.
Of course, what matters now is whether they can build on this or instead see re-escalation.
Incentives for a US-China trade deal
Ninety days isn’t long in the world of trade negotiations. Realistically, major deals can take many years to thrash out.
However, we think that both sides have obvious incentives to reach some kind of agreement before the end of this year at least.
The US knows that sky-high blanket tariffs on China could trigger more inflation, supply chain disruptions, queries over its fiscal sustainability, and higher interest rates.
Likewise, China will want to secure an agreement with its largest single national trading partner. While its government is borrowing massively to cushion the trade blow to its economy this year, it cannot sustain such efforts at these levels. Indeed, it may even have to tighten its belt in 2026.
Despite the mutual need for a deal, we also recognize the many hurdles.
Obstacles to a trade deal
As its determined response to the US escalation in April showed, China is not for caving in.
We cannot envisage it signing a new and lasting deal that leaves it materially worse off than it was before Trump’s return to power.
China especially opposes any deals between US and other trading partners that seek to isolate China or otherwise harm its interests.
Likewise, it will surely resist any requirement to quickly eliminate its massive goods export surplus with the US.
Moreover, China seems likely to insist on some gains from a new deal. These might include the elimination of the 20% tariff specifically imposed to pressure China to stem the flow of chemicals that contribute to the deadly synthetic opioid fentanyl into the US. Easing sanctions, relaxed export bans and wider geopolitical space might also count as wins.
We are unsure if the US would agree, say, to keep tariffs where they were before this latest stage of the trade war began or to eliminate other barriers erected in recent years. A failure to start rebalancing trade immediately might also prove unacceptable to the Trump administration.
The US may also be reluctant to agree not to insert “anti-China” clauses in trade deals with other countries. However, this requirement may make striking other trade deals more difficult with other countries. After all, China is a larger trading partner than the US with 148 countries in 2024.
These countries may not want to harm another big economic relationship, while absorbing higher tariffs from the US.
Still, we do see scope for concessions. China may be willing to offer a combination of a fentanyl crackdown, lower export subsidies, easier export controls, lower import and investment barriers, as well as greater domestic demand stimulus.
Any potential deal is likely to involve China allowing its currency to strengthen. The yuan has lagged other currencies’ rise amid US dollar weakness this year. So, we see scope for it to appreciate if a deal can be done.
The US might concede the 20% fentanyl related tariffs, but the appetite to ease on sanctions, export curbs and geopolitical space may be more limited.
How might China’s growth perform this year?
Currently, consensus expectations are for Chinese GDP growth of 4.2% for 2025. However, this is likely to get revised higher.
China’s fiscal and monetary stimulus are already bearing fruit. In the first quarter, GDP expanded 5.4% year over year. Fixed investment – outside of real estate – is picking up. Infrastructure projects are at the forefront of this. Even real estate transactions and prices have stabilized.
The tariffs are likely to affect manufacturing. Activity was weak in April, but there may now be a surge of production ahead of the August 10 tariff deadline.
Overall, we believe that the net tariff hit on the Chinese economy will be slightly less than 1% this year, while the fiscal offsets are much bigger. GDP growth may thus slow a bit to 4.5-5% for 2025. That would only be slightly short of the government’s target. If a trade deal can be struck in the third quarter, growth could end up higher still.
Chinese equity market considerations
So, with stronger policy stimulus, less severe tariff impact, and potential currency strength, investors may have another look at Chinese equities.
We would look to potential beneficiaries of policy support and greater domestic demand.
These include sectors like staples, tech hardware, autos or even real estate and banking. Such areas have been outperforming and seeing earnings forecasts rise during 2025 so far.
Artificial intelligence (AI) development also looks attractive. Advances in AI are a key priority for the authorities and business.
Consumer demand beneficiaries and AI related players seem likely to lead performance and may also prove more resilient if further downside risks materialize.
