US-China tariff war phase 2 outlook: Retaliation, stimulation, and negotiation

The 2 April US tariff announcement was a shock to China. In addition to the 20% tariff hikes announced in February-March, the US weighted tariff rate on China was hiked to 65%, one of the highest in the world. China’s rapid responses were another surprise. We think this is because China is better prepared this time round; the speed of the counter measures showed a high level of coordination among ministries.

Phase 2 of the tariff war has begun

On 14 April following several rounds of tit-for-tat retaliations, the effective US tariff rate on Chinese imports increased to 145% (with exemptions for pharmaceuticals, technology hardware and semiconductors). China retaliated by increasing tariffs on US imports to 125%. China also announced that it will not respond to further tariff hikes on Chinese goods, since at this point higher tariffs “would no longer have any economic significance.”  Such levels are likely to put bilateral trade to a temporary halt. And China vowed to “fight until the end”.

Hence, we believe the US-China tariff war has entered its second phase, which will test the endurance and strength of both parties.

China is adopting a three-step: retaliation-stimulation-negotiation approach rather than rushing into compromises. China has long understood that it cannot both safeguard its core interests and make concessions that satisfy the US. Its tariff retaliation aims to bring both sides to the negotiation table sooner. In fact, the US Secretary of Commerce has confirmed that negotiation between both parties has been going on through middlemen. In the meantime, we are confident that China will launch more stimulus to prevent any big decline in its GDP growth and markets. Moreover, China will also diversify sales away from the US market to other neighbouring countries, as China policymakers held the “Central Conference on Work Relating to Neighbouring Countries” recently, with President Xi scheduled to visit Vietnam and other Southeast Asian countries.

What’s the impact on China’s exports to the US?

Based on China’s National Bureau of Statistics data, China’s total exports to the US were almost US$525 billion in 2024. Most of China’s export industries have low to moderate ability to pass on the higher tariffs to customers. Chinese companies need to enhance product value, explore new markets, optimise supply chains, and reduce dependency on the US market. As for the government,  support is needed for small-and-medium enterprises (SMEs) in affected industries.

Highest impact areas:

• Electronics, machinery, and light industry constitute about 70% of exports to the US and are the most significantly impacted given most of their pricing advantage will be lost.
• Low-profit margin products (light industry eg. apparel, footwear, hair products, toys, plastic, rubber, and leather goods).
• Cross-border e-commerce platforms and merchants that used to benefit from tariff exemption on low value parcels (under US$800).
• High dependence on the US market such as light industry, furniture and appliances, and electrical equipment.

 

What’s the impact on China’s imports from the US?

Based on China’s National Bureau of Statistics data, China imported US goods totalling about US$164 billion in 2024. Overall, the impact on China’s import dependency looks manageable, due to the availability of alternative sources for low-end products and the already limited access to high-end US products.

• High-end dependence on US

High-end chips, aircraft engines, optical equipment, medical devices, and innovative pharmaceuticals.

China’s dependency on high-end chips from the US is already low given existing export restrictions. Many high-end chips are imported from countries like Singapore, which are not considered as direct imports from the US.

• Low-end dependence on US:

China has significant imports in sectors like energy, light chemicals, and agricultural products such as soybeans. But these lower-end products are relatively easy to source elsewhere, such as soybeans from Brazil. However, in the short term, the process of switching supply channels may increase costs across the supply chain.

What immediate support have we seen? 

• Capital markets

Central Huijin (a state-run investor ultimately controlled by the Ministry of Finance.) and other state-owned enterprises made a concerted effort to intervene in domestic stock markets to counter the selloff unleashed by the US trade war.

• Chinese currency

The combination of exchange rate depreciation and interest rate cuts may trigger US retaliation. Thus, the optimal solution for China is stability – stabilising the exchange rate and letting it fluctuate within a limited range.

• Industry self-help

JD.com has announced that it will purchase RMB200bn worth of export goods over the year to help exporters. More than a dozen other online platforms, including Alibaba’s supermarket chain Freshippo Meituan, Douyin (ByteDance), Kuaishou, and VIP.com, as well as bricks-and-mortar retailers like Yonghui, CR Vanguard, and Lianhua have announced similar efforts.

Meanwhile, Chinese exporters are aiming to diversify their customer base in the EU and developing countries.

What stimulus levers can the Chinese government pull?

China’s GDP growth target remains around 5% for 2025. Given little room for near-term de-escalation, the government is actively working on economic stabilisation measures, which could include interest rate cuts, reserve requirement ratio reductions, share buybacks, corporate bailouts, as well as exchange rate and financial markets stabilisation.

• The central bank’s monetary policy stance has shifted to “appropriately loose”, a term not used since the 2008 Global Financial Crisis.
• The RMB 2 trillion fiscal package announced during the National People’s Congress is likely to be brought forward, aiming to boost consumption, recapitalise banks, invest in infrastructure, manufacturing and real estate.
• Additional stimulus of RMB1-1.5 trillion could be announced if the high tariffs remain and negotiations take longer than expected.

 

Investor implications  

Navigating the complexities of the current trade war, it is imperative to recognise the broader socio-economic transformations underway in China. The ongoing shift from a ‘scale manufacturing’ era to an intelligent, digital age is reshaping the investment landscape in China. The tech sector is likely to attract significant government support, being critical in US-China competition and also benefits from the rise of the digital economy.

Aside from the tech sector, domestic consumption has significant room to grow, given it only accounts for circa 56% of GDP in 2023, significantly below the global average of 76%. The dual circulation strategy aims to build China’s domestic production and consumption capabilities as a defense against future economic shocks.

Ultimately, the trade war with the US could even be a positive for China, if it becomes a powerful catalyst speeding up the transformation to an economy that is more dependent on domestic demand.