Our Global Head of Fixed Income Research and Public Policy
Michael Zezas discuss the latest developments in U.S.-China
relations and how they could affect investors.
Read more insights from Morgan Stanley.
----- Transcript -----
Welcome to Thoughts on the Market. I’m Michael Zezas, Global Head
of Fixed Income Research and Public Policy Strategy.
Today, we’re talking about the U.S. and China—why the
relationship remains complicated, and what it means for
markets.
It’s Tuesday, Oct 21st, at 12:30pm in New York.
If you’ve been following headlines, you know that U.S.-China
relations are rarely out of the news. But beneath the surface,
the dynamics are more nuanced than the daily soundbytes suggest.
Investors often ask: Are we headed for a decoupling of the two
economies, or is there room for cooperation?
The answer, as always, is—it’s complicated.
Let’s start with the basics. The U.S. and China are deeply
intertwined economically, but strategic competition has
intensified. Recent years have seen tariffs, export controls, and
restrictions on technology transfer. Yet, there’s still plenty of
trade between the two countries, and both economies are dependent
on each other for growth and innovation.
So what’s going on now?
In recent weeks, China has moved to tighten rare earth export
controls and the U.S. has proposed 100 percent tariffs in return.
If this came to pass, these events could mark a clear economic
split. But given the interdependencies we just cited, neither
Washington nor Beijing seems eager for a true split, at least not
anytime soon. The economic costs would be staggering, and both
sides know it. So, a truce seems more likely, perhaps with
somewhat different terms than the narrow semis-for-rare earths
agreement they made this spring. And longer term, this episode
seems to be a part of a broader dynamic, where rolling
negotiations and truces are more likely than either a durable
trade peace or a hard economic decoupling.
For fixed income investors, this drives some important
considerations.
First, U.S. industrial policy is ramping up, with clear
implications for AI infrastructure. AI is an area where the U.S.
views it as essential that they outcompete China. Supported by
renewed CapEx incentives from the latest tax bill, it’s clear to
us that U.S. companies will be pushing further into AI
development, where my colleagues have identified $2.9 trillion of
data center financing needs over the next three years, about half
of which will come from various credit markets. And for credit
investors, this presents an important opportunity.
Another consideration is how markets will balance near-term
growth risks with an array of medium term growth possibilities.
As our U.S. economics team has pointed out, the evidence suggests
that corporates haven’t yet been forced to make tough decisions
about passing on or absorbing tariff costs, underscoring that
trade-related growth pressures aren’t yet in the rearview. The
ongoing U.S. government shutdown doesn’t help either. It’s all a
good argument for why bond yields could move lower in the near
term.
But also, we should expect yield curves could steepen more, with
higher relative yields in longer maturities. This would reflect
greater uncertainties around higher fiscal deficits, inflation,
and economic growth. Our economists have been calling out the
mixed messages in economic data, as well as a U.S. fiscal
sustainability picture that appears reliant on acceleration in
corporate CapEx for a manufacturing and AI-driven growth
burst.
In sum, the U.S.-China relationship is evolving, with global
implications that don’t lend themselves to easy narratives or
quick fixes. Our challenge will continue to be crafting
investment strategies that reflect durable policy undercurrents,
the signal amid news headline noise.
Thanks for listening. If you enjoy the show, please leave us a
review wherever you listen and share Thoughts on the Market with
a friend or colleague.
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