The recent de-escalation in U.S.-China tariffs suggests we are likely past the peak of tariff uncertainties, leading to a strong rally in risk assets. However, are we really out of the woods?

A temporary trade truce with China

On May 12, the U.S. agreed to reduce the tariff hike on Chinese imports from 145% to 30% for 90 days, bringing the final tariff rate on Chinese goods to 41% (including the 11% existing tariff). Chinese tariffs on U.S. imports were also reduced to 27.5% (17.5% existing + 10% retaliatory tariffs).

Treasury Secretary Bessent hinted at the possibility of further reduction of the 20% tariffs on China related to fentanyl, if China takes sufficient measures to address the issue. This could be good news for Canada and Mexico, who are currently facing similar tariffs for the same issue.

On the flip side, if no deal is struck within the next 90 days, the initial 24% reciprocal tariffs on China could return. The administration also stressed that while they do not intend to decouple from China completely, they do intend to decouple “for strategic necessities,” implying strategic goods could face further trade barriers.

How have tariffs impacted trade data so far?
Container ship volumes from China to the U.S. declined significantly in April but are showing early signs of stabilization following the first round of negotiations. A further short-term rebound in trade is possible as the 90-day tariff truce prompts further frontloading, but a significant decline in 2H 2025 is likely, as much of the demand was pulled forward.

Amidst such risks, markets were relieved by the overall export resilience demonstrated in China’s April exports data. Despite record-high tariffs from the U.S. in April, Chinese exports grew 8.1% year-over-year (y/y), beating market consensus. However, there was an apparent divergence: Chinese exports to the U.S. fell 20.2% y/y in April (after growing 9.1% y/y in March) but were offset by a 22.1% y/y growth in exports to ASEAN markets. This again showcased China’s ability to re-route trade and diversify export markets, similar to the 2018-2019 U.S. trade tensions. 

But a long road ahead for negotiations

U.S. trade agreements typically take an average of 18 months to sign and 45 months to implement, according to the Peterson Institute for International Economics. The expectation for formal agreements to be completed within the 90-day window may be optimistic, especially when dealing with multiple economies simultaneously.

However, preliminary deals provide a framework for how trade can continue in the near term and offer insights into the Administration’s trade agenda.

• The U.S.-UK deal indicates that while sectoral tariffs may have flexibility, a 10% baseline tariff is likely a non-negotiable floor. This may have likely motivated Japan, who previously sought exemptions from all tariffs, to now signal a willingness to accept partial tariff reductions rather than complete elimination.
• The U.S.-China deal revealed the Administration’s flexibility in the face of economic risks but could also prompt other markets to maintain their positions against the U.S. It also foreshadows the Administration’s focus on strategic goods.

We expect tariffs to settle towards a 10% universal tariff, with China and specific strategic goods subject to higher tariffs.  

What does this mean for the U.S. economy?

The temporary rollback on tariffs against China has reduced the U.S. tariff rate from 23.7% to 13.3%, marking a notable 10 percentage point reduction (Exhibit 1). While this reduction lowers recession risks, it does not eliminate them. At 13.3%, tariffs remain more than five times higher than the 2.4% at the end of 2024 and at levels not seen in eight decades. Meanwhile, additional industry related tariffs on pharmaceutical and semiconductors are still possible. Thus, current tariffs continue to pose material risks to supply chains, profit margins, and inflation.

One major channel through which tariffs impact the economy is confidence. We are closely monitoring whether the recent weakness in the confidence data (Exhibit 2) can stabilize following the U.S.-China trade truce, which could prevent the still-resilient hard economic data from deteriorating significantly. Fiscal stimulus from the reconciliation bill in Congress may eventually offset some of the growth drag posed by tariffs.

Overall, while policy risks have peaked and recession is not our base case, we are not completely out of the woods. We expect the U.S. economy to continue slowing given materially high tariff levels and lagged effects from earlier escalations. Beyond trade, lower immigration and spending cuts continue to pose downside risks.

Investment implications

The easing of trade tensions materially reduced the left tail risk (worst-case-scenario), leading to a ~20% relief rally in the S&P 500 from April 8 to May 19 and pushing forward price-to-earnings (P/E) ratios above 21x.  However, while recession risks have decreased, they are not actually low. The same applies to tariff rates.

Hard data will likely reveal a growth slowdown in the coming months due to lagged effects, although investors may be more willing to look through the weakness given recent positive developments. However, downward adjustments to U.S. earnings-per-share growth (currently at 9% for 2025) will likely continue as analysts incorporate tariff impacts. Although these adjustments could be partially offset by the fiscal bill making its way through Congress, fiscal concerns could push yields higher, posing a headwind for equities.

While there is a potential narrow path for higher U.S. equities if growth remains resilient and yields stabilize, a lower U.S. dollar and narrowing growth differentials continue to favor global diversification. As elevated volatility is likely to persist, investors should continue managing volatility through diversification, income strategies, or option overlays.

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