Our recent coverage has focused on rising risks to the U.S.-China tech/rare earths truce that has been in place since President Trump and General Secretary Xi Jinping met in Busan, South Korea, last November. In particular, our series on China’s role in the global AI buildout (see HERE) noted that tech tensions are headed for data center supply chains, with risks for both Chinese and U.S. companies. Recent developments show that these tensions are becoming visible even earlier than we expected.
On Tuesday, Reuters reported (link HERE) that the U.S. Federal Communications Commission (FCC) is considering a ban on U.S. imports of new models of optical transceivers, with a focus on imports from China. According to the report, FCC officials hope to announce and implement the ban by the end of the year. The news led to price declines in Wednesday’s Asia trading session for Chinese industry leaders Innolight (-7.3%) and Eoptolink (-5.3%), both of which are highly reliant on the U.S. market.
Whether and how the FCC moves ahead with this proposal depends on several factors. One is whether alternative suppliers in the U.S. or acceptable third countries (such as Japan and Taiwan) can fill the gap left by Innolight and Eoptolink. The FCC’s ban will presumably apply only to imports of new models, rather than a rip-and-replace of Chinese companies’ existing installed base. The ban would impact the industry’s upcoming transition from 800G to 1.6T modules. Industry contacts have some doubt that U.S./third country companies can quickly fill the gap.
Beijing Will Push Back
The other consideration for Washington is Beijing’s potential retaliation, which looks even more likely based on the latest signals from the Chinese Ministry of Commerce (MOFCOM). MOFCOM has responded only rhetorically to the report of the FCC’s optical transceiver ban. However, in an important signal on Wednesday, MOFCOM announced a series of retaliatory measures in response to recent FCC bans on imports of drones, robots, and inverters, as well as an expansion of U.S. sanctions on Chinese companies under the Uighur Forced Labor Prevention Act. MOFCOM’s retaliatory measures include: tightening restrictions on exports of drone technology to the United States; restricting access to China’s market for seven companies involved with FCC and forced labor compliance investigations; and announcing a national security review of China’s imports of printing and copying equipment (a novel move that mirrors aspects of recent FCC moves).
What is particularly significant about MOFCOM’s announcements is that they explicitly say that Beijing views the FCC’s import bans as violations of the Busan tech and supply chain truce. The implication is that if the FCC does move ahead with a ban on imports of optical transceivers, Beijing will retaliate with its own export restrictions.
One particular risk is that Beijing could further tighten restrictions on exports of indium phosphide, the substrate material for high-speed lasers made by Coherent and Lumentum. Beijing’s controls on indium phosphide since February 2025 have already been enough of a concern for the White House to include Coherent’s CEO in the U.S. business delegation to Trump’s trip to China in May (discussed in our first AI supply chain report HERE). A scenario where Beijing aggressively tightens indium phosphide restrictions (which it could do without a new formal announcement) could potentially slow the U.S. data center buildout, while advantaging Chinese competitors which retain domestic access to indium phosphide supplies.
The FCC’s newly prominent role in anti-China actions is a wildcard. The FCC has typically not been a lead agency in China policy, but chairman Brendan Carr has pushed it into a muscular role. FCC is filling a political vacuum left by the U.S. Department of Commerce, which previously had the lead role in addressing technology supply chain risks involving China. In the last year, Commerce has been passive in this area as well as in export controls, with Commerce Secretary Lutnick not inclined to approve actions that could disturb the U.S.-China truce. While Carr and the FCC are in theory subject to the same political considerations, the FCC’s traditional role as regulatory agency – typically sitting outside the normal interagency policy coordination process – may make it harder for an understaffed White House to weigh in, especially if Trump’s commitment to the trade and tech truce fades after U.S. midterm elections.
Risks Around Tech Supply Chains Rise in November
The fact that the U.S. and China are in a period of very active diplomacy limits the near-term risk of major supply chain escalation. Xi Jinping is due to visit the U.S. this fall (likely in late September) to reciprocate Trump’s state visit to China in May. Both sides will be wary of taking actions that disrupt the trip. At the same time, these tensions all but ensure that the visit will be mostly cosmetic and lack ambitious new deliverables. It is hard to make new economic commitments at a time when both countries are aggressively trying to reduce dependencies on each other for critical supply chains.
We have stressed that the U.S.-China tech and supply chain truce will come under greater pressure in 2027. Recent developments already show the pressures building, and Trump may be less motivated to defer actions against China once the midterm election is over. The risks of tit-for-tat supply chain measures increase if the two sides do not renew their tariff and tech truce, which expires on November 10 – just one week after midterms. Beijing is eager to use Xi’s upcoming visit to lock in an extension well ahead of that deadline, ideally to last the remainder of Trump’s term. U.S. officials are less inclined to rush and may defer a decision until after elections.
Bottom Line: The Reuters report may represent a trial balloon from the FCC, and an early warning signal for U.S. hyperscalers to begin de-risking decisions. However, the direction of travel from the FCC seems clear: the agency has the intent and political backing to address perceived national security risks from Chinese supply chains. The Department of Defense added Innolight to its 1260H list of Chinese military companies in June, which carries little practical impact but signals pressure on companies contracting to DoD to not use the firm’s products.
Our base case is that the FCC imposes a ban on imports of optical transceivers targeting China, but the timing could slip well into 2027 given potential complications finding alternative suppliers. Beijing has signaled that it will respond forcefully, with restrictions on indium phosphide a prime candidate. The most important near-term watchpoint is Xi’s visit, and signals by the two sides as to the degree of commitment to extending the tariff and supply chain truce beyond this November.
Two Other Vectors to Monitor
In addition to potential FCC moves on supply chain dependencies, we will be monitoring two other vectors for U.S.-China tech tensions:
- Chinese Open-Weight AI Models. The near-term probability of the U.S. imposing bans or other severe restrictions on the use of Chinese AI models is low. One reason is U.S.-China engagement: not only the Xi visit, but also an initial U.S.-China AI safety dialogue that Treasury Secretary Bessent and Chinese Vice Premier He Lifeng are due to hold sometime before Xi’s visit. Another reason is the U.S. domestic debate, with key tech leaders such as Nvidia aggressively lobbying U.S. policymakers not to ban Chinese open weight models and hand an effective duopoly to OpenAI and Anthropic. The policy debate is not going away, but near-term measures will likely be moderate (restrictions on U.S. government/contractor use, regulatory disclosure of use of Chinese models, etc.).
- China’s Access to U.S. Compute. Chips remain the central theater of U.S.-China AI competition – the key advantage that the U.S. has in training and deploying advanced AI models, and the chokepoint most concerning for Beijing. Indeed, we expect U.S. efforts to limit competition from Chinese models to ultimately focus on compute restrictions, such as closing loopholes that have reportedly allowed Chinese AI labs to access Nvidia chips through third countries and through cloud providers. Refraining from new controls on China’s semiconductor industry is the key commitment for the U.S. to maintain the supply chain truce, so policymakers will tread carefully for now. But we do not think it is politically sustainable for the U.S. Commerce Department to hold off on new semiconductor restrictions over the medium term. Major advances in China’s ability to produce advanced AI chips at scale could prompt further tightening of access to semiconductor manufacturing tools, including ASML’s DUV lithography equipment.
