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Written by: Marina Valentini, Mary Park Durham, Jennifer Qiu
After a stimulus-fueled rally in 3Q24, Chinese equities have recently stumbled, declining 3.2% since the U.S. election1. Domestically, challenges like policy uncertainty and real estate sluggishness persist, while externally, new risks are emerging. President Trump has intensified pressure on China by imposing an additional 10% tariff on Chinese goods and initiating an investigation into its trade practices and compliance with the 2020 Phase One Deal, with an April 1st deadline. Recent events indicate that tariffs are being used as negotiating leverage, suggesting the situation will keep evolving.
As we brace for what’s next, it’s worth revisiting the 2018-2019 “Trade War” when U.S. tariffs on Chinese imports rose from 3% to 10% by early 2020. China’s playbook could include:
- Retaliatory tariffs: During Trade War 1.0, China responded with multiple rounds of retaliatory tariffs, tripling its tariff rate on U.S. imports over a two-year period. This time, China has responded by filing a case with the World Trade Organization, a largely symbolic gesture given the WTO dispute settlement system is defunct. It also plans to impose tariffs on U.S. energy imports and other items starting February 10th, which allows time for negotiation.
- Currency depreciation and export diversification: From peak to trough within the trade war period, the CNY depreciated by 16% vs. the USD, helping offset the impact of tariffs and facilitating trade diversification toward other markets. For example, ASEAN gained 3ppts of China’s export share from 2019-2023. However, further depreciation is constrained, with the USDCNY now at 7.19 compared to 6.51 at the start of 2018, and the PBoC showing reduced tolerance for currency weakening due to capital outflow pressures.
- Export restrictions and U.S. company crackdowns: China has 50% market share in the global production of cobalt, lithium, and nickel and 75% in electric batteries and solar cells. Therefore, it holds substantial leverage over other countries. In response to U.S. tariffs, China plans to expand key mineral export controls and has launched an antitrust probe into Google, indicating potential challenges for U.S. businesses operating in China.
- Fiscal stimulus: A 20%+ effective tariff rate could hurt China’s GDP growth, due to lower investment, consumption, and spillover effects from reduced business confidence. This, along with existing challenges, could require increased fiscal stimulus in 2025.
Presidents Trump and Xi are expected to speak this week, which could ease tensions. However, uncertainty surrounding the permanence of tariffs may continue to cause short-term volatility in Chinese and U.S. assets. While supply chains have been significantly restructured due to Trade War 1.0 and COVID-19, enhancing companies' resilience to higher tariffs, some are still vulnerable. For example, large-cap U.S. tech firms derive approximately 14% of their revenues and 16% of their inputs from China, making them more exposed in the case of broad retaliatory tariffs. Meanwhile, Chinese companies generate 87% of their revenues domestically and only 3% from the U.S1. Thus, fiscal stimulus remains the most important driver for Chinese equities, with higher tariffs possibly prompting more government action. Overall, broad diversification is essential while leaders work to resolve trade challenges.
The yuan depreciated throughout the 2018-2019 Trade War
U.S. tariff rate on imports for consumption from China and USDCNY
Source: FactSet, U.S. International Trade Commission, J.P. Morgan Asset Management. Labels refer to when the tariffs were announced, and thus, would precede the actual implemented increase in tariffs. Various tariffs on solar panels and washing machines were announced in Jan. 2018, 25% tariff on steel and 10% on aluminum were announced in Mar. 2018, 25% tariff on Lists 1&2 was announced in Jun. 2018, 10% tariff on List 3 was announced in Sep. 2018, 25% tariff on List 3 was announced in May 2019 (initially set at 10%), 15% tariff on List 4A was announced in Aug. 2019. A temporary truce was announced in Dec. 2018 at the G20 summit. Phase 1 deal was officially announced in Dec. 2019 and signed in Jan. 2020.
1 Based on MSCI China Total Return Index in USD.
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