Our U.S. Public Policy Strategist Ariana Salvatore unpacks how
China’s announced rare earth export controls and signals of
sweeping U.S. tariffs could impact global supply chains, markets
and economic growth.
Read more insights from Morgan Stanley.
----- Transcript -----
Ariana Salvatore: Welcome to Thoughts on
the Market. I'm Ariana Salvatore, Morgan Stanley's U.S. Public
Policy Strategist.
Today I'll talk about a development keeping markets and investors
on alert: a re-escalation of U.S. China trade tensions.
It's Friday, October 17th at 10am in New York.
Since April, the U.S. and China have been in what we've been
calling a very delicate detente. Remember, President Trump paused
the additional reciprocal tariffs after Liberation Day.
Since then, we've been consistently skeptical that the pause was
durable enough to actually allow the U.S. and China to come up
with a full-fledged trade agreement. But now we're equally as
skeptical that the current escalation will lead to a material
disruption in the bilateral relationship.
So, what happened last week? China announced stricter export
controls on rare earths, which are really critical for
manufacturing everything from electric vehicles to defense
equipment and advanced electronics. So, in response, the Trump
administration on Friday announced a proposed 100 percent tariff,
said to go into effect November 1st across all Chinese exports to
the U.S. That date matters because that's around the same time
that Presidents Trump and Xi were scheduled to meet at the
upcoming APEC Summit in South Korea.
When we think about this most recent escalation, it's pretty
significant because China accounts for about 70 percent of global
rare earth mining, and 90 percent of processing and refining. A
lot of countries around the world – the U.S. Japan, Korea, and
Germany – all rely heavily on these imports from China. And so
potential new export controls mean that every economy may have to
start negotiating bilaterally with China to secure supplies,
which raises the risk of supply chain disruption across Asia,
Europe, and the U.S.
Looking ahead, we're thinking about four potential scenarios for
how the current U.S.-China trade tensions could play out. The
most likely outcome, which is our base case, is a return to the
recent status quo following a period of rhetorical escalation and
likely a reset of expectations heading into this APEC meeting.
That's because we think both the U.S. and China would prefer to
maintain the existing equilibrium to an abrupt supply chain
decoupling.
That equilibrium is effectively chips for rare earths. So, the
U.S. receives China's rare earths, and then in return the U.S.
exports some of its chips to China. But that equilibrium doesn't
necessarily mean that the temporary implementation of trade
barriers like higher tariffs or more export controls are off the
table.
The broader trajectory we think will continue to point toward
competitive confrontation, which is a bipartisan strategy that
encompasses both these traditional trade tactics as well as
unilateral domestic investment – either vis-a-vis direct federal
spending, or the government taking more stakes in companies
involved in these critical industries. So, think things like the
IRA, the CHIPS Act, and other bipartisan pieces of
legislation.
So, in the near and medium term, expect to see these trade
barriers persisting and a bipartisan push toward U.S. industrial
policy, as the U.S. attempts to undergo selective de-risking from
China. Our base case scenario anticipates further short-term
tensions, but ultimately a limited agreement that avoids deep
structural changes.
We've also thought through some alternate scenarios. So, in one
downside case, you could see temporary escalation past November
1st. Both sides could fully implement their proposed policies,
but after doing so, come back to the status quo once the economic
costs become apparent.
A more severe downside scenario involves durable escalation. So,
in this case, we would see both countries maintain trade barriers
for an extended period. That outcome would see both the U.S. and
China decide to change calculus on that equilibrium, so that no
longer holds. And in that case, we could see a push toward
decoupling and a significant strain on supply chains.
Finally, our last scenario reflects a quick de-escalation in
which heightened rhetoric actually acts as a catalyst for renewed
negotiations and a potential framework agreement that could
result in some tariffs, but most likely at lower levels than
initially proposed.
So, what does this all mean? In the base case, our economists
expect China's GDP growth to slow to below 4.5 percent in the
second half of 2025, with exports supported by robust non-U.S.
shipments. Our equity strategists in this outcome see the
volatility actually providing a dip buying opportunity, given
that they see a rolling recovery that began earlier this
year.
However, a more durable escalation could possibly prolong China's
deflation and necessitate further policy adjustments. Similarly,
that outcome could negate the early cycle rolling recovery thesis
here in the U.S.
Thanks for listening. If you enjoy the show, please leave us a
review wherever you listen and share Thoughts on the Market with
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