The 90-day reduction on tariffs between the US and China is a positive development, but some questions remain.
On May 12, the United States and China announced a 90-day reduction on tariffs that stands as a temporary de-escalation of the nations’ trade war. US tariffs on Chinese goods dropped from 145% to 30% (10% plus the 20% fentanyl-related tariffs) and China’s tariffs on US goods fell from 125% to 10%. The nations will continue to negotiate with the hopes of aligning on a longer-term resolution.
Raymond James Chief Investment Officer Larry Adam provides insight into how this news impacts his team’s views on the equity and fixed income markets, and the economy.
Tariff rates above 100% rendered much of US-China trade practically unworkable, evident in the sharply lower volumes of marine shipping between the two countries. China is the third-largest source of US imports – accounting for 14% of US imports in 2024 – and the disruption in trade could have led to product shortages and empty shelves the longer the trade war dragged on. The 90-day de-escalation alleviates fears of such a scenario.
The not-so-good news is that even 30% is still a very hefty tariff on China. A key question mark is whether that 30% will continue after the next 90 days. In that same context, let’s recall that July 8 is the deadline for trade deals with everyone other than China. Last week’s deal with Britain maintained a 10% tariff, even though the US has a trade surplus with Britain. It stands to reason that long-term tariffs with some countries may be higher than 10%, given that the US has a trade deficit with most other countries.
Given the latest announcement, the estimated proposed global tariffs will be reduced from 22.5% to 15.8%. While significant progress has been made, many questions remain about the tariffs delayed until July 8 on several countries, supporting our view that ultimately the effective tariff rate may settle around 15% to 17%. In the meantime, the trade-related question marks will continue to feed into a high level of uncertainty among consumers and businesses alike. For this reason, we maintain our view that US GDP will grow approximately 1% in 2025, with the probability of a recession at 50%.
Markets reacted positively on May 12 following the tariff reductions and the S&P 500 was up ~16% from the recent lows set on April 8. The rally is unsurprising given the reduction in tariffs on China to 30% was much better than the anticipated 60+%. This has alleviated severe downside risks for the economy and corporate earnings, providing a somewhat better, though not optimal, level of clarity for business planning.
The question now: With the S&P slightly above our year-end target of 5,800, is the market poised to break out to all-time highs? We do not think so, for a few reasons.
With weaker economic growth estimates as compared to the start of the year (our forecast of ~1% versus +2.4%), the prospect of slightly hotter inflation, and broadly the same level of interest rates, we see limited room for multiple expansion from current levels. Therefore, earnings will need to be the driver from here. This is consistent with history, as multiples typically compress during the third year of a bull market.
Since the start of the trade war, we reduced our 2025 earnings estimate for the S&P 500 from $270 to ~$250-255. The reason for this was twofold: 1) reduced economic activity would weigh on sales growth; and 2) tariff-related costs would pressure margins. When calculating our earnings estimate, we used a weighted average tariff assumption of 15% as we expected the initial severe tariff levels to be negotiated downward. We still look at the mid-teens as a reasonable assumption for ultimate destination of the weighted average tariff rate. Assuming GDP growth of ~1%, we still feel comfortable with S&P 500 earnings at $250-$255. This equates to a ~4% downward revision from the current consensus estimate of $264. These downward revisions will likely weigh on the equity market over the coming months.
The past month’s rally in the equity market is justified as the most severe tariff impacts have been taken off the table. In the face of still-high uncertainty and building economic headwinds amid a weighted average tariff rate that may be ~5x higher versus the start of the year, we maintain our year-end of 5,800 for the S&P 500. As a result, we expect limited near-term upside in the equity market overall and volatility to remain elevated.
Treasury yields have pushed higher as risk assets have recovered as trade tensions de-escalate between the US and China. Concerns about the economic outlook have eased, and market expectations for Federal Reserve (Fed) rate cuts have been pared back considerably. Over the past two weeks, nearly two Fed rate cuts have been priced out in 2025 – the market now expects only two cuts this year – and market expectations for the Fed’s next rate cut is now not expected until September. This hawkish repricing has put upward pressure on Treasury yields since the start of May, with the policy-sensitive 2-year yield back to ~4%, and the 10-year Treasury yield up to 4.45%.
While recent trade developments are a step in the right direction, the ultimate destination for tariffs is still much higher from where it was at the start of the year. This should pose headwinds for the economy, which the Fed will respond to later this year. However, until the hard economic data starts to turn decisively lower, the 10-year Treasury is likely to remain in its recent 4.0%-4.6% range.
The US-China trade deal is the latest case study of the White House walking back its tariff agenda, thereby alleviating worst-case fears for the economy and markets. This explains why the S&P 500 has posted healthy gains since bottoming in early April and is nearly back to where it started the year. That said, there are still plenty of question marks vis-à-vis trade with China and other key trading partners. While encouraging developments, our views have not changed. We still expect the US economy to narrowly avoid a recession, with no change to our 4.25% 10-year Treasury or 5,800 S&P 500 year-end forecasts.
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