By David Rees
The current pace and flux of geopolitics continues to disrupt markets - keeping investors across the globe on tenterhooks. The US/China relationship in particular is the most consequential bi-lateral relationship in the world, and in a way, is the axis around which other events are turning.
There has been a significant amount of action around the US/China relationship since Trump took office in January which is having ripple effects on international markets and economies.
We have seen a series of measures, including two rounds of 10% tariffs which has raised the effective tariff rate for Chinese exports into the US to above 30%.
There are also a host of potential coercive economic measures which are in the works in the US.
Is it possible to predict where we are headed?
Against this backdrop, our geopolitical expert at Schroders, Sir Sebastian Wood, points to two prevalent theories regarding where the US/China relationship is heading.
The first holds that there is a geopolitical strategy of bifurcating the global economy into two blocks - one centred on the US, protected by large tariff wall and seeking to isolate China. In this context the US’s approach to the Ukraine and Russia conflict is seen as an effort to pull Russia toward the US and drive a wedge between Russia and China.
The second view is that the US’s actions thus far under Trump are part of a grand bargaining plan with China, encompassing economics, trade and other issues like fentanyl smuggling, TikTok and possibly even Taiwan.
But Sir Wood believes that how the Trump administration will behave in practice will be messier than the geopolitical chess these scenarios describe. The reality will likely be less like a conceptual blueprint and more opportunistic and transactional as Trump attempts to strike short-term deals with China. And the Chinese authorities seem to want to keep conversations open – while they have retaliated to trade tariffs, their response has been measured to avoid escalation.
So, what does all this messiness mean for markets?
When it comes to economic forecasting, dealing with the usual economic indicators to come up with a view can be tricky enough. Now, on top of all of that, we have a number of different policy levers, and no one quite knows which announcements will stick or not. Trying to pull all these factors together, narrow it down and arrive at the correct view is almost impossible now, which is why markets are so volatile.
The tariff issue is a good example of this. In China, tariffs are sticking but in Canada there has been a back and forth. With tariffs seemingly on-again-off-again, we just don’t know where we stand, and markets have really traded on these headlines at the moment.
And the end of coercive policy moves is nowhere in sight. According to Bloomberg there are US$1.7 trillion of tariff threats in the pipeline.
Are the US recession rumours true?
When you dig into the weeds of the data and strip out the noise, the US economy looks in decent shape and market concerns about a recession seems overdone. There is some noise going on in the jobs market around the Department of Government Efficiency (DOGE) and some noise in the consumer data which is affecting sentiment, but when you peel it back and strip out some of the volatility the US economy does not seem poised for recession. One unknown, however, is the impact of trade relationship uncertainty on animal spirits, which is very hard to quantify.
Where does this leave China’s growth story?
Official statements from the Chinese government are for 5% economic growth in 2025. However, while the official numbers are likely to then reflect this 5% on paper come the end of the year, the Schroders economics team tries to track the underlying cyclical forces within the economy rather than just assuming you're going to get straight line growth.
Although our leading indicators suggest some green shoots of recovery, there is still a bit of softness in the near term in the domestic economy. We would like to see the government short circuit that cyclical sogginess with fiscal stimulus.
While there are some steps being taken, stimulus has been restrained as the Chinese government appears to be taking a wait-and-see approach in terms of US trade relations. They are likely keeping some powder dry because they don't really know what's going to happen with the US administration. Should the US announce a 60% tariff, the impacts on China's economy would be massive, and it would make sense to then respond with large-scale stimulus.
An unwinding of the US exceptionalism narrative
During the US election race, the dominant narrative was that if we saw a second Trump administration, US exceptionalism would continue, the dollar would strengthen, the US economy would shine, and emerging economies would suffer. Indeed, this is what happened initially. According to Vera German, value equity fund manager at Schroders, we are now seeing an unwinding of the confidence behind that market narrative and a consequent repricing. The US is becoming a less certain bet, and China and other emerging markets are becoming more attractive.
So, the story of the year is China’s resurgence, which is partly off the back of a bit more optimism around the government’s steps to recognise and address economic issues. The other driver behind the China stock market recovery is the emergence of DeepSeek. The Chinese-developed AI model came out earlier this year and shocked markets across the world. It had a significant impact on US tech stocks because it hinted at this possibility that AI model development might be subject to innovation and cheaper methods of training models.
But Abbas Barkhordar, Asian equity fund manager at Schroders cautions against getting too optimistic on Chinese tech stocks too soon. Firstly, he says that the jury is still very much out on the return on investment (ROI) into AI servers and development in general. In China, ROI is an even bigger question because it's a much more competitive market in terms of cloud and internet services.
Secondly, he says that there's also a very different culture in terms of how much can be priced and charged for those services because AI investment is viewed as a national priority.
“Historically, when we look at the solar panel example, the Chinese government was very keen on developing that capability which resulted in overcapacity and a need to export. Our approach is therefore to look deep into supply chains at hardware names in tech which stand to benefit from increased tech spend, but are a bit more agnostic about who the eventual customer will be. What this means is that they aren’t reliant on a specific eventual winner of the AI race - because as we've seen this year with the emergence of DeepSeek, the favourites to win can change in an instant,” says Barkhordar.
Always be prepared for a paradigm shift
The events of this year have proved once again that nothing is certain. One must always be prepared for a paradigm shift, and, as German says: “If anyone tells you that something is certainly going to happen, it’s usually prudent to hedge just in case it doesn’t.”
This is an especially useful approach in a time of such uncertainty and highlights the benefits of active management. Being able to adjust investment strategies quickly in real-time can be more beneficial than passively following the markets.
David Rees, Head of Global Economics at Schroders.
BUSINESS REPORT