China-US Negotiations: How Much "Ice Breaking"?

The U.S. has reduced tariffs on China from 145% to 30%, which may not be the ultimate limit for this phase. In recent years, many "easing" beginnings between China and the U.S. have occurred in Switzerland. For example, the "prelude" to the 2023 meeting between the U.S. and Chinese leaders was diplomatic contacts in Switzerland. This week, trade talks between China and the U.S. in Switzerland once again brought "surprises" to the market, with the core issue being the extent of tariff cancellations/suspensions. The U.S. has not "discriminated" against China, and within the next 90 days, the newly added tariff level for this year will drop from 145% to 30%, with the 20% fentanyl tariff also having the potential for further reduction:

First, the retaliatory tariffs imposed on April 8 and thereafter will be canceled. This aligns with expectations and common sense;

Second, the 34% "original" equivalent tariffs will be handled similarly to other countries. The baseline of 10% will be retained, while the remaining 24% will be suspended for 90 days, which will be one of the key points in the upcoming negotiations.

Third, the 20% fentanyl tariff requires additional negotiations. This is similar to the handling of Canada and Mexico, requiring discussions with officials from public security/drug enforcement. If an agreement can be reached, the tariff level imposed this year may further decrease to 10% in stages.

Additionally, it is worth noting that in addition to equivalently reducing tariffs, China has also added a clause to "suspend or cancel non-tariff countermeasures against the U.S. starting from April 2, 2025." We believe that restrictions on rare earth exports may be a critical "vulnerable point" for the U.S. economy.

So what are the possible paths forward?

Future negotiations between China and the U.S. will mainly focus on two main lines: first, negotiations based on broad trade and market access, primarily concerning the suspended 24% tariff portion; second, negotiations on the fentanyl issue, mainly concerning the 20% tariff. In terms of difficulty and complexity, the latter (20%) may be easier to achieve, especially considering that the head of the U.S. Drug Enforcement Administration (DEA), Terry Cole, is about to "take office"—having just undergone Senate hearings on April 30.

We can further clarify the framework by combining it with the U.S.-UK agreement. From the perspectives of revenue, negotiations, and supply reconstruction: 1) The 10% baseline equivalent tariff is likely very difficult to eliminate, even the UK, which has a nearly balanced trade with the U.S., cannot "escape"; 2) The portion of equivalent tariffs above 10% will need to be exchanged for "market access," non-tariff barriers, exchange rate levels, etc., and this aspect of negotiation is expected to be the most time-consuming and labor-intensive; 3) In terms of industry tariffs, the UK's experience may not be applicable to China: industry tariffs have many safety considerations, and China and the UK differ in this regard

Therefore, within the next three months, the tariffs imposed by the United States on China this year may drop to a minimum of 10%, but there is a possibility that tariffs on China may rise after 90 days. The 20% tariff on fentanyl may be canceled, while the postponement of the 24% tariff may not be completely lifted.

What is the impact of reaching an agreement?

Domestically, how much of a boost will the joint statement have on exports? Before the joint statement was released, based on the 145% new tariffs imposed by the U.S. on China, we expected the logic of Chinese exports to be "almost non-tradable to the U.S. + 90 days of re-export hedging." In this scenario, China's exports in the second quarter may decline year-on-year to around -5% (for details, see "Second Quarter Exports: How Much Can 'Re-export' Hedge?"). In the latest situation of "retaining 30% tariffs," China's exports and nominal GDP year-on-year may still be dragged down by 5.5 and 1 percentage points, respectively, but the extent has been significantly reduced compared to the "145% tariff rate" scenario, and second-quarter exports are expected to maintain positive growth:

On one hand, the downward risk of China's exports to the U.S. has been fully released in April (the 30% new tariffs roughly dragged down year-on-year exports to the U.S. by 37.4 percentage points, and the marginal decline in China's year-on-year exports to the U.S. in April has exceeded 30 percentage points), and a marginal recovery is expected in the next 90 days.

On the other hand, the 30% retained tariffs are still generally higher than the tariff exemptions the U.S. offers to other countries (only retaining a 10% tariff), and the momentum for "re-export" is expected to weaken but will continue.

Authors of this article: Shao Xiang, Zhang Yunjie, Source: Chuan Yue Global Macro, Original Title: "China-U.S. Negotiations: How Much 'Ice Breaking'?"

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