A new tariff equilibrium?

It’s taken just one month for the US and China to shift from an all-out trade war to a temporary truce. Even by the Trump administration’s standards, the speed of the détente—which sharply cut tariffs back to pre-“Liberation Day” levels for 90 days—is surprising, given the wide gap between the two sides just weeks ago.

Global markets have quickly responded by pricing out worst-case trade and recession scenarios. The S&P 500, Stoxx 600, and MSCI Asia ex-Japan are up nearly 20% from their 8 April lows, led by a strong rally in tech, while credit spreads have compressed back to pre-April levels.

With the majority of the reciprocal tariff shock now on hold, the key question for investors is whether a new tariff equilibrium has finally been found.

A slowing US economy, lingering trade uncertainty, and fiscal risks also prompt us to shift the US dollar to Unattractive this month. With the de-dollarization trend set to continue, we use current levels to hedge USD positions or diversify exposure into preferred currencies like the AUD and JPY. We upgrade the CNY to Neutral on a better post-truce growth outlook.

That is, of course, impossible to answer with a high degree of certainty. But broadly speaking, we think our base case—which sees the effective US tariff rate settling around 15%—has become more likely following the recent de-escalation.

While that represents a better tariff outcome than feared in the immediate aftermath of “Liberation Day”, it’s still more challenging than what many had expected at the outset of the year. Indeed, such an outlook implies little change from today’s tariff rates and represents a headwind to growth, but not one that’s so great as to drive the US economy into a recession or Asia-Pacific into a double-digit export contraction.

What could lead to a better result? We think a lasting deal with China that further rolls back tariffs, a bigger reduction in overall effective US tariff rates from bilateral agreements and/or legal challenges, and a stronger-than-expected US economy could keep regional export growth positive and spur capital inflows.

But closing a deal with China will likely prove tricky, there’s been little meaningful progress on other agreements at the halfway point of the 90-day reciprocal tariff pause, and the tariff impact has yet to show up in hard data. And though the Trump administration has become more sensitive to market and political pressure, it is unlikely to give up on its tariff goals like reindustrialization, reducing trade deficits, and increasing revenue to fund its fiscal agenda, which faces increasing deficit concerns following the recent Moody’s downgrade and ongoing bond volatility.

So, with markets already pricing in plenty of tariff relief and equities trading decisively higher than pre-”Liberation Day” levels, we think broader upside is limited from here and downgraded US stocks to Neutral in mid-May. We also remain Neutral on the regional index, but continue to see alpha opportunities in mainland China’s tech sector, Taiwan, and India. Though regional tech stocks have strongly rebounded over the last few weeks, they were harder hit in the tariff escalation phase and still offer a better risk-reward compared to the broader market, in our view.

While bond yields could rise further in the weeks ahead in anticipation of higher US fiscal deficits, we believe current levels present an opportunity for investors to diversify equity exposure and lock in attractive portfolio income. We prefer medium-duration APAC investment grade bonds to avoid the volatility at the longer end of the curve.

A slowing US economy, lingering trade uncertainty, and fiscal risks also prompt us to shift the US dollar to Unattractive this month. With the de-dollarization trend set to continue, we use current levels to hedge USD positions or diversify exposure into preferred currencies like the AUD and JPY. We upgrade the CNY to Neutral on a better post-truce growth outlook.

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