Trade Truce: Economic Optimism Tempered by Uncertainty

The recent agreement between the United States and China to temporarily scale back reciprocal tariffs is generating cautious optimism among economists. The deal, which entails a 90-day pause in the escalating trade war between the two economic giants, is projected to provide a notable boost to America’s economic growth prospects for the remainder of the year, dampen inflationary pressures, and alleviate the looming threat of a recession.

However, this initial enthusiasm is tempered by lingering concerns regarding the long-term sustainability of the truce. Some forecasters caution that there is no guarantee the agreement will hold beyond the three-month hiatus. They point to the failure of the two nations to reach a comprehensive, enduring resolution during President Donald Trump’s first term as a reminder of the deep-seated complexities and potential for renewed conflict.

The immediate reaction to the announcement of the trade agreement has been overwhelmingly positive, particularly within financial markets. Investors have responded favorably, evidenced by a surge in major stock indices. In early afternoon trading, the Dow Jones Industrial Average experienced a significant jump, soaring by approximately 900 points, while the S&P 500 index climbed by 2.5%.

Economists are now reassessing their growth forecasts for the U.S. economy, taking into account the potential impact of the tariff reductions. Kathy Bostjancic, Chief Economist at Nationwide, has revised her projections upward. She now anticipates the U.S. economy to expand by a range of 0.5 to 1 percentage point from the fourth quarter of 2024 through the end of the current year. This represents a substantial improvement from her previous forecast, which had predicted flat growth for 2025. While this revised outlook is encouraging, it still falls short of the economy’s robust expansion of nearly 3% recorded last year.

UBS, while acknowledging the positive implications of the agreement, is taking a slightly more conservative approach. The firm is forecasting a 0.4% increase in economic output as a result of the trade truce.

Beyond its impact on economic growth, the agreement is also expected to have a moderating effect on inflation. Bostjancic anticipates that inflation, which is currently hovering around 2.5% based on an average of various measures, will peak at 3.4% by the end of the year. This is a notable decrease from her earlier projection of 4%. In a note to clients, Bostjancic emphasized that the unexpected scale of the tariff reductions implemented by both the U.S. and China has played a crucial role in averting a potential recession.

Ryan Sweet, chief U.S. economist of Oxford Economics, has similarly adjusted his economic outlook, reflecting the reduced risk of a recession. He has lowered his recession probability assessment for the year from over 50% to a more manageable 35%.

A key element of the agreement involves significant reductions in reciprocal tariffs. The U.S. has committed to lowering its tariffs on Chinese imports from a staggering 145% to a more moderate 30%. Similarly, China will reduce its duties on U.S. shipments from 125% to 10%. Furthermore, China has agreed to eliminate “non-monetary” trade barriers, such as its bans on exports of critical minerals.

The previously imposed high tariffs, coupled with lesser fees on imports from other nations, were expected to have a detrimental impact on U.S. consumers. These tariffs were projected to sharply increase prices for a wide range of goods, thereby eroding consumers’ purchasing power. This, in turn, could have led to a potentially harmful combination of high inflation and slow economic growth, a scenario often referred to as stagflation.

The suspension of the highest tariffs on Chinese goods, in conjunction with the 90-day pause on double-digit import taxes on numerous other nations that was implemented last month, has brought some relief. However, UBS points out that the average U.S. tariff rate remains elevated at approximately 15%. While this represents a decrease from the 24% level that prevailed before the China pact, it is still significantly higher than the 2% to 3% average that was in place before President Trump took office.

Despite the projected boost to economic growth, it is important to note that the overall growth rate is still expected to be weaker than what was predicted before the trade war. However, economists generally agree that the agreement should significantly diminish the likelihood of a recession.

Major retailers had been expressing concerns about potential product shortages and empty store shelves in the lead-up to the crucial back-to-school and holiday shopping seasons. Sweet notes that the trade agreement will help to mitigate these supply-chain disruptions.

However, Sweet also emphasizes the potential for renewed trade tensions in the future. He states, “A future escalation remains possible, if not likely, as tariffs are used as a negotiating tactic.”

Capital Economics, in a note to its clients, echoed this sentiment, cautioning that “there is no guarantee that the 90-day truce will give way to a lasting ceasefire.” The research firm highlighted the history of failed attempts to achieve a comprehensive trade agreement, pointing to the “comprehensive economic dialogue” launched in 2017 during Trump’s first term. This initiative was ultimately abandoned later the same year due to the inability of the two sides to make meaningful progress, paving the way for the imposition of tariffs. The prospect of history repeating itself remains a significant concern among economists and policymakers. The temporary nature of the current agreement and the lack of a long-term framework leave the door open for future disputes and potential trade disruptions.