Song Xuetao: The "All Walks of Life" Behind the Geneva Agreement

US-China Tariffs Exceed Expectations "Downgrade"

On May 12, a joint statement was released following the US-China Geneva trade talks, in which the US promised to cancel 91% of the retaliatory tariffs imposed on Chinese goods on April 8, and to suspend 24% of the 34% equivalent tariffs imposed on Chinese goods on April 2 for 90 days, while retaining the remaining 10% tariffs. China also implemented corresponding reciprocal cancellation and suspension measures, and both sides agreed to establish a mechanism for further economic and trade consultations.

At this current juncture, how should we understand the strategic significance behind the Geneva agreement and its impact on the market?

Strategic Considerations of China and the US

In terms of the US-China talks, China is not in a hurry, while the US is clearly more eager to achieve breakthroughs on tariffs. According to the Chinese Ministry of Foreign Affairs, this meeting was held in Switzerland at China's "request from the US" (rather than on US soil), which marks a significant reversal from the US's previous "hope that China would take the initiative to call." China's position is firm and clear, resolutely opposing the US's excessive imposition of tariffs, but always maintaining an open attitude towards dialogue based on equality, respect, and reciprocity. The reversal in the US's attitude can be attributed to the following reasons:

First, China's "tit for tat" game strategy has led non-US countries to adopt a wait-and-see approach, prompting the US to urgently seek a breakthrough. At the beginning of the tariff negotiations, China adopted a strong strategy of reciprocal countermeasures, and its exports and economy remained resilient, effectively weakening the US's leverage while gaining valuable time for re-export and negotiations with other countries. Ultimately, the cost of ending negotiations was far lower than a direct compromise. Non-US countries have also gradually realized the effectiveness of the delay strategy; for example, Japan shifted from actively negotiating with the US from the outset to not rushing to demand the cancellation of all tariffs, even directly resisting the tariff proposals put forth by the US. As the originator of the tariff war, the US's core external demand is "everything for profit," and the longer the conflict lasts, the more unfavorable it becomes for economic coercion.

Second, under internal political and economic pressure, Trump urgently needs to achieve a phased outcome in the tariff war. According to the US Congressional Budget Act of 1974, the House of Representatives must complete the review of the new fiscal year's appropriations bill by June 30 each year, with "tax cuts" being one of the most important contents under market consensus. Tax cuts mean a decrease in fiscal revenue, so the US urgently needs to supplement fiscal revenue through other means, making the continuation of lower tariffs a more feasible option with less political pressure compared to extreme tariffs.

On the other hand, summer and autumn are traditionally the Christmas ordering seasons in the US. High tariffs have already led to a de facto trade embargo between China and the US. If tariffs affect the stocking for the Christmas season (typically orders are placed at least three months before sales), it is highly likely to translate into significant political pressure domestically in the US, thus Trump urgently needs to achieve substantial breakthroughs on the tariff issue

From China's perspective, although the US-China agreement involves moderate concessions in the game, there are also practical benefits.

On one hand, the suppressive effect of high tariffs on exports will eventually become apparent. Although in the short term, the export data for China in March and April exceeded expectations, this was mainly supported by companies rushing to export, re-export, and go overseas. By country, exports to the US in April fell by 21% year-on-year, while exports to ASEAN rose by 21% year-on-year. By product category, the export growth rates for intermediate goods and capital goods in April were 8.5% and 8.2%, significantly higher than the export growth rate for consumer goods at -4.1%. This indicates that while China is increasing its re-exports to non-US markets, it is also intensifying its efforts to avoid direct tariffs from the US, supporting the export data for April.

However, the real pressure on exports may begin to emerge from June to July. First, there is about a two-month time lag from when US companies place orders to when goods are exported. The PMI new export orders in April dropped significantly by 4.3 percentage points to 44.7%, hitting a new low for 2023, and it is expected that export growth may start to weaken from early June. Second, the previous "rush to import" in the US has somewhat overdrawn demand. The inventory replenishment cycle that began in the second half of last year in the US is expected to continue until mid-year, and weakening US demand will suppress China's exports in the third quarter.

Therefore, quickly reducing tariffs with the US not only secures economic certainty but also reduces the long-term sustained impact on exports, which is a strong practical consideration.

On the other hand, achieving phased progress in negotiations with non-US parties is also an important prerequisite for China to reach an agreement. Since April 9, while the US-China tariffs have continued to escalate in retaliation, China has also been advancing negotiations with ASEAN and the EU simultaneously. With ASEAN, after the Chinese leader completed state visits to Vietnam, Malaysia, and Cambodia in mid-April, several bilateral cooperation documents were signed, further promoting regional strategic coordination and industrial chain integration, deepening infrastructure construction in ASEAN, and laying a solid foundation for Chinese companies to go overseas and re-export. With the EU, both sides reached an agreement on "setting a minimum price for domestic electric vehicles," replacing the tariff scheme for electric vehicles in 2024; China lifted sanctions on European Parliament members; and both sides agreed to quickly initiate consultations to discuss market access, business environment, and other issues, paving the way for future China-EU investment agreements In a valuable window period of more than a month, China and other non-U.S. countries have made milestone negotiation progress, which is not only a long-term benefit for Chinese companies going abroad but also a key to breaking the deadlock in the tariff game.

How will the market evolve after the tariff cooling?

Regarding economic data, the overdraft effect brought by this year's export front-loading is still worth paying attention to. After June and July, the downward pressure on export data still exists, but it is clearly better than the substantial embargo scenario under a 145% high tariff rate.

As for domestic policy, the 425 Politburo meeting specifically mentioned that "domestic economic work should be combined with external trade struggles." After achieving good results in the first phase of external trade struggles, the pressure on domestic economic work has also eased accordingly. The market's biggest focus is on incremental fiscal policy, which is expected to gradually land after the export growth rate declines in June and July, to offset the economic and employment pressures brought by the export decline.

With the cooling of the China-U.S. tariff game, market uncertainty has eased, U.S. stocks and A-shares have risen together, the RMB exchange rate and the U.S. dollar index have rebounded, and gold has corrected. Previously, speculative funds quickly flowed into gold, pushing up its volatility; now, the adjustment of gold after the improvement in risk appetite is the main reason for the expansion of this adjustment, but the long-term driving force for gold as a scarce safe-haven asset remains unchanged.

The signing of the China-U.S. Geneva Agreement has become a clear short-term benefit for U.S. stocks, moderately alleviating the economic recession pressure brought by high tariffs. Subsequent negotiations between the U.S. and non-U.S. countries may proceed more smoothly, and the rebound in U.S. stocks has also boosted the U.S. dollar index from a funding perspective.

For the domestic market, on one hand, the pressure on export chain enterprises such as machinery and automobiles has eased; on the other hand, the acceleration of domestic substitution in fields such as semiconductor equipment and industrial mother machines remains unchanged. The trend of enterprises hedging trade risks through overseas capacity layout and technological upgrades remains unchanged, and enterprises with core technological advantages going abroad are still the main investment line in the medium to long term.

This article is authored by Song Xuetao and Chen Hanxue, sourced from Xuetao Macro Notes, original title: "Song Xuetao: The 'Living Conditions' Behind the Geneva Agreement"

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