SUMMARY
- President Trump’s move to exempt high-tech electronics from “reciprocal tariffs” reflects successful lobbying from key U.S. corporations such as Apple, and concerns over the potential political pushback from households facing sharp price increases on popular consumer items; however, Trump’s warning that many of the exempted goods will be hit with “sectoral tariffs” shows that he is seeking to manage the transition costs of a tariff regime to which he appears firmly committed.
- There is a decent chance that the exemption creates the conditions for a modest US-China de-escalation in coming months, but not for a broad deal that brings major tariff relief; Beijing views Trump’s exemption as a partial retreat and evidence that China can withstand the political pain of a trade war longer than Trump.
- The end-April Politburo meeting is a key watchpoint for how much support Chinese leader Xi Jinping is willing to provide to bolster growth this year; our basecase is an investment-focused stimulus package that results in real GDP growth of 4% and nominal growth of 2.5% this year.
The US announced late on Friday that it is exempting smart phones, laptops, video monitors, semiconductors and semiconductor equipment from President Trump’s 125% “reciprocal” tariffs on imports from China. These products are still subject to Trump’s 20% “fentanyl” tariffs imposed in March.
The move reflects intensive lobbying from major US tech companies, most notably Apple. It may also reflect the White House’s concern about the political blowback from households who were about to face the prospect of a potential doubling in price for iPhones and other high-profile consumer items.
But these exemptions are likely to prove temporary, at least at current rates. Trump posted on social media on Sunday that the tariffs are not “exceptions” and that the exempted goods will be subject to forthcoming “sectoral tariffs” that aim to reshore semiconductors and related supply chains. Presumably, the sectoral tariffs will not be at the punishing rates of current China tariffs.
The exemptions represent Trump’s evolving balancing act on tariffs. On the one hand, the last week has clearly demonstrated that he is sensitive to the very high adjustment costs that his aggressive tariff plans have threatened to impose on markets and the economy. At the same time, he is at least rhetorically committed to tariffs and defensive about claims that he is caving in to pressure. Put another way, Trump is seeking to manage the transition costs of what remains an ambitious effort to remake US (and global) supply chains.
Beijing will regard Trump’s move as a partial retreat rather than a de-escalation of the tariff dispute, and a validation of Xi’s strategy of staying tough against Trump rather than making quick concessions in hope of a deal. Xi believes that he has a higher political pain tolerance than Trump, and also that it is foolish to give up leverage if Trump has additional measures – such as sectoral tariffs – still to come. This points to a willingness to continue to explore off-ramps with Trump, but not to make major concessions until Xi is certain that Trump is truly ready for a deal.
So, where do US-China dynamics go from here? Below we lay out illustrative scenarios through end-June. The probabilities here are not meant as forecasts – the game theory between Trump and Xi is much too uncertain for that – but as a sense as to how we see the relative balance of risks.
Basecase: Modest de-escalation (40% probability). Trump’s exemption move creates at least a temporary pause in what had been a rapid action-reaction cycle between Washington and Beijing since April 2. China’s Ministry of Commerce referred to the exemptions as a “small step” towards correcting Washington’s “wrong practice” of reciprocal tariffs. The two sides thus have the opportunity to explore at least modest de-escalation, given that the status quo is not comfortable for either side. Trump’s exemptions still leave punishingly high tariffs on around 80% of US imports from China, including toys, microwaves, lithium-ion batteries, video game consoles and a dizzying array of household goods.
We thus see a reasonable chance that Beijing and Washington will find a way to – at least temporarily – bring tariff rates down to the roughly 65% level announced under Trump’s reciprocal tariffs (April 2) and Beijing’s response (April 4), before two rounds each of tit-for-tat retaliation. There is even an outside shot that Trump could agree to postpone the 20% fentanyl tariffs imposed in March.
For such moves to happen, we expect that a Trump-Xi call is necessary. It probably won’t happen quickly. Xi is reluctant to request a call from Trump and look like he is begging for relief. The who-moves-first question is resolvable, but Xi must also have assurances that a call will lead to some unwinding of tariffs. Hence, we expect the two sides to have considerable legwork ahead and would watch for a Cabinet-level call (such as between Treasury Secretary Bessent and Vice Premier He Lifeng) as a sign that they are making progress.
Note that while a modest de-escalation would increase the probability of a broader US-China trade deal this year (such as would be necessary to bring US-China tariff rates below 30%), the probability will remain low. It will take a fairly ambitious deal involving Chinese purchase and investment commitments before Trump relaxes tariffs on China – the key target of his tariff campaign – and Beijing is too distrustful to make such commitments anytime soon.
Further escalation into non-tariff measures (30% probability). There are still clear dangers of further escalation. The risks grow if the economic pain of tariffs increases in the US and Trump responds with frustration that Beijing has not reached out for accommodation. In this scenario, the two sides will reach further into the toolkit of non-tariff measures:
- On the US side, we would see a somewhat higher risk of sanctions on China (especially if tensions rise over Beijing’s support for Venezuela, Russia, or Iran). Additional US export controls on Chinese tech firms are possible. We do not see broad delisting of Chinese companies from US exchanges as likely to happen abruptly but would expect increased political and regulatory scrutiny over this issue and a higher risk that specific Chinese companies are added to the Treasury Department’s investment blacklist of Chinese military-linked companies.
- On the Chinese side, we expect export controls over rare earths (and possibly other critical supply chains) to be Beijing’s main weapon if escalation climbs. In this scenario, such controls will impact US supply chains – especially in defense and aerospace – before end-June. We do not see Beijing as likely to weaponize its holdings of US Treasuries in anything other than an extreme scenario, given potential financial and diplomatic costs to China and limited effectiveness in hurting the US (the Fed is capable of offsetting China’s sales).
A tense stalemate at current tariff levels (15% probability). A failure to revive communication in coming weeks, but a desire by Trump to avoid further market woes with additional escalation, could lead the current pause to become a stalemate around current tariff levels (for most products, above 100%). Trump would likely grant additional specific exemptions to US firms to make this more politically tolerable.
Overall, this stalemate would not be comfortable, and we would expect it to come under repeated challenges from non-tariff measures from both sides. Indeed, one of the dangers of a stalemate – familiar from the US-China trade war in the first Trump administration – is that when he is not actively pursuing a deal, Trump often allows national security officials to implement a hawkish agenda against China in areas such as technology controls. And Beijing would likely continue its use restrictions on rare earths to squeeze – if not disrupt – some US supply chains.
Active deal-making (15% probability). We see a low probability that the two sides will move towards discussion of a US-China deal in the next few months, such as necessary to remove or delay a portion of Trump’s reciprocal tariffs on imports from China. On the Chinese side, the stumbling blocks are uncertainty over what Trump will do next, an assumption that the US is out to contain China, and a belief that China is in the stronger position politically.
Xi will be reluctant to make concessions to Trump if he sees the potential for further measures directed at China in coming weeks, including Trump’s promised sectoral tariffs. And Beijing will watch to see what happens with Trump’s negotiations with other countries during the 90-day pause. If Trump compels other trading partners to take aggressive actions towards their imports from China, it will undermine a US-China truce. On the flip side, if Trump fails to reach major deals with other partners it may embolden China in staying tough.
Simply put, Trump will need to be very eager for a deal with China to create the political conditions necessary for Beijing to make an attractive offer.
CHINA’S MACRO RESPONSE
We will cover China’s evolving economic response to the trade war in coming days, but our basecase remains the same:
- We expect additional stimulus measures that offset half of the impact of the trade war (2 percentage points hit to China’s GDP). This would bring 2025 real GDP growth to around 4% and nominal growth to around 2.5%, with risks to the downside (especially in an escalatory scenario).
- Stimulus measures will focus on investment, but with an incremental nod to increased support for consumption. As a rule of thumb, we expect a 70/30 investment/consumption mix this year, compared with an 80/20 mix last year.
- The end-April Politburo meeting is a key watchpoint for the amount of support Xi Jinping is willing to provide to reinforce growth. There is a risk that Xi, assuming a drawn-out trade war, will look to preserve policy room and that demand-side stimulus will be insufficient and behind the curve (putting our 4% growth basecase at risk).
- We expect the PBOC to carefully manage the exchange rate and allow only modest depreciation in the next two months. But doing so on a sustainable basis will require either US-China de-escalation or an effective stimulus response to reinforce macro confidence.
