David Rees | Senior Economist | Emerging Markets | Schroders | mail me |
The current pace and flux of geopolitics continue to disrupt markets, keeping investors worldwide on tenterhooks. The US/China relationship, in particular, is the most consequential bilateral relationship in the world. In a way, it is the axis around which other global events are turning.
There has been a significant amount of action surrounding the US/China relationship since Trump took office in January. This action is having ripple effects on international markets and economies. We have witnessed a series of measures, including two rounds of 10% US trade tariffs. These have raised the effective tariff rate for Chinese exports into the US to above 30%. Additionally, a host of potential coercive economic measures are currently in the works in the US.
Is it possible to predict where we are headed?
Against this backdrop, there are two prevalent theories regarding the direction of the US/China relationship.
The first theory suggests a geopolitical strategy to bifurcate the global economy into two blocks. One block would centre on the US, protected by a large tariff wall, while seeking to isolate China. In this context, the US’s approach to the Ukraine and Russia conflict is seen as an effort to pull Russia toward the US. The goal is to drive a wedge between Russia and China. The second theory is that the US’s actions under Trump are part of a grand bargaining plan with China. This plan encompasses economics, trade and other issues like fentanyl smuggling, TikTok and possibly even Taiwan. However, Sir Wood believes that the behaviour of the Trump administration will likely be messier than the geopolitical chess these scenarios describe.
– Sir Sebastian Wood, Geopolitical Expert at Schroders
In practice, the reality will likely be less about a conceptual blueprint and more about opportunistic and transactional moves. Trump will attempt to strike short-term deals with China. Meanwhile, Chinese authorities seem keen to keep conversations open. Though they have retaliated against trade tariffs, their response has been measured to avoid escalation.
So, what does all this messiness mean for markets?
Economic forecasting is already tricky enough when dealing with the usual economic indicators. Now, on top of that, we have numerous policy levers, and no one quite knows which announcements will stick.
Trying to pull all these factors together and narrow down the correct view is nearly impossible. This uncertainty is why markets are so volatile.
The trade tariff issue is a good example of this. In China, trade tariffs are sticking, but in Canada, there has been back-and-forth. With trade tariffs seemingly on again and off again, we simply don’t know where we stand. As a result, markets have been trading based on these headlines.
And the end of coercive policy moves is nowhere in sight. According to Bloomberg, US$1.7 trillion worth of trade tariff threats are still in the pipeline.
Are the US recession rumours true?
When we dig into the weeds of the data and strip out the noise, the US economy appears to be in decent shape.
Market concerns about a recession seem overblown. There is some noise in the jobs market, particularly around the Department of Government Efficiency (DOGE) and some issues in consumer data, which are affecting sentiment. However, when we peel back the layers and remove the volatility, the US economy does not appear poised for a recession.
One unknown, however, is the impact of trade relationship uncertainty on animal spirits. This impact is very hard to quantify.
Where do trade tariffs leave China’s growth story?
Official statements from the Chinese government project 5% economic growth in 2025. However, while the official numbers will likely reflect this 5% on paper by the end of the year, our economics team focuses on tracking the underlying cyclical forces within the economy. We prefer this method over assuming straight-line growth.
Although our leading indicators suggest some green shoots of recovery, there remains some softness in the near term within the domestic economy. We would like to see the government shorten this cyclical weakness with fiscal stimulus.
While there are some steps being taken, stimulus has been restrained. The Chinese government appears to be adopting a wait-and-see approach regarding US trade relations. They likely want to keep some flexibility because they are unsure about the future direction of US policy.
If the US were to announce a 60% trade tariff, the effects on China’s economy would be massive. In such a case, it would make sense for China to respond with large-scale stimulus.
Trade tariffs and the US exceptionalism narrative
During the US election race, the dominant narrative suggested that if there were a second Trump administration, US exceptionalism would continue. The US dollar would strengthen, the US economy would shine and emerging economies would suffer. Indeed, this is what initially happened.
We are now seeing an unwinding of the confidence behind that market narrative. This has led to a consequent repricing. The US is becoming a less certain bet, while China and other emerging markets are becoming more attractive.
– Vera German, Value Equity Fund Manager at Schroders
So, the story of the year is China’s resurgence. This resurgence is partly due to increased optimism surrounding the government’s steps to recognise and address economic issues.
Another key driver of China’s stock market recovery is the emergence of DeepSeek. This Chinese-developed Artificial Intelligence (AI) model, which came out earlier this year, shocked markets across the world. It had a significant impact on US tech stocks because it hinted at the possibility that AI model development could be subject to innovation and cheaper methods of training models.
We caution against getting too optimistic about Chinese tech stocks too soon. the jury is still very much out on the return on investment (ROI) for AI servers and development in general. In China, ROI is an even bigger question, given the highly competitive market in cloud and internet services.
– Abbas Barkhordar, Asian Equity Fund Manager at Schroders
Furthermore, there is a very different culture in terms of how much can be priced and charged for these services, as AI investment is viewed as a national priority.
Historically, when we look at the solar panel example, the Chinese government was very keen on developing that capability. This led to overcapacity and a need to export. As such, we advise looking deep into the tech supply chains at hardware companies. These companies stand to benefit from increased tech spending, but are more agnostic about who the eventual customer will be.
This strategy is important because it makes them less reliant on a specific eventual winner in the AI race. As we have seen this year with the emergence of DeepSeek, the favourites to win can change in an instant.
Always be prepared for a paradigm shift
The events of this year have proved once again that nothing is certain. One must always be prepared for a paradigm shift.
As German says, “If anyone tells you that something is certainly going to happen, it is usually prudent to hedge just in case it does not.”
This is especially useful in times of uncertainty and highlights the benefits of active management. The ability to adjust investment strategies quickly in real-time can often be more beneficial than passively following the market.
