Author: Matt Peterson, Editor: Li Jingying
The US stock market surged on Monday after the Trump administration indicated it would not impose massive tariffs on China, but the market and economic outlook remain unclear.
The stock market finally breathed a sigh of relief. After the Trump administration clarified that it would not impose massive tariffs on China, the US stock market rose sharply on Monday, but it was like celebrating before not shooting oneself in the foot.
After the scattered confetti and empty champagne bottles from Monday's market rally were cleared, the market and economic path still appeared shrouded in fog.
An agreement with China has not been reached, and the tariffs the US has imposed on China and other countries remain at levels that could seriously impact the US economy. The tax reform, another major policy measure the Trump administration hopes will boost growth, is far from complete and may even exacerbate bond investors' concerns based on its current direction.
The Dow Jones index soared over 1,100 points after US Treasury Secretary Benson and US Trade Representative Grier stated in Geneva that the US would only impose additional tariffs of 30 percentage points on Chinese trade, not the previously threatened 125 percentage points. The 25% tariffs imposed on most Chinese goods during Trump's first term remain unchanged.
US Treasury yields, including 10-year and 30-year bond yields, rose, which may reflect traders moving from fixed income to higher-risk stocks.
However, whether this trade truce will produce lasting peace remains to be seen. Benson and Grier stated at their post-agreement press conference that they would never have gotten China to the negotiating table without serious threats.
Even if this perspective is accepted, initiating negotiations is insufficient to resolve the long-term economic issues between the US and China. This will require tougher negotiations, currently conducted under the awareness that the US might retreat due to new pressures in financial markets.
The backdrop is that Trump and Benson promise to maintain most of the new tariffs they've implemented, including up to 55% tariffs on Chinese goods and 10% tariffs on goods from other parts of the world.
White House Press Secretary Karoline Leavitt confirmed last week: "The President is determined to maintain the 10% baseline tariff."
The Yale Budget Lab estimates that this tariff level (Chinese tariffs plus baseline tariff) could cost an average household $2,300 and cause the US economy to "continuously shrink by 0.4%".
As growth slows and the Federal Reserve remains vigilant about potential price increases, the Trump administration will urgently hope tax reform can help promote growth. However, this is not easy as the US debt situation is going from bad to worse.
Joshua Rauh, a finance professor at Stanford University and senior researcher at the Hoover Institution, said: "The biggest risk to Trump's economic plan, the biggest risk to the current overall direction, is the deficit and debt."
Public debt is around 100% of US GDP, and at this level, even small interest rate changes could have massive impacts on taxpayers.
The current actions of the US Congress seem to suggest that increasing more debt is feasible, but Rauh says Congress's assumptions might be mistaken. Bond traders have already warned that the $28.6 trillion US Treasury market has formed a new risk premium driven by US policy uncertainty.
The nonpartisan Congressional Budget Office predicts that in 10 years, 22 cents of every $1 in federal spending will go towards interest payments. However, this painful prediction assumes an average 10-year US Treasury yield of 3.8% over the next 10 years.
Rauh said: "Is there any reason to doubt this? You can get the market's prediction for 10-year Treasury yields 10 years from now. This is the so-called 10-year forward rate for 10-year US Treasuries, which is more than a percentage point higher than the Congressional Budget Office's prediction."
Rauh said that if this situation doesn't change, 29 cents of every $1 in federal spending will go towards interest payments.
Tax negotiations might solve this issue, but progress so far has not been encouraging. The House Ways and Means Committee released details of a comprehensive tax bill on Monday, with a surprising proposed increase in state and local tax caps, causing divisions within the Republican Party.
How to combine these policies to secure votes from almost all Republican members of the House and Senate remains unclear.
As if legislative risks weren't large enough, Republicans must also raise the debt ceiling before August. Foreign investors seem to be paying attention: they reduced purchases of US Treasuries in last week's 30-year bond auction. The bond market's warning signals are obvious to anyone paying attention.
It's easy to think tariffs and tax processes are separate. But stock investors need to understand the connection between them.
Analyst Jawad Mian wrote in his newsletter "Stray Reflections" on Monday: "Every rally eventually reaches this point: moving from reacting to news to needing something deeper to believe in. Trade news brought comfort, tax cuts brought hope. If legislative progress stalls or the plan gets diluted, it could weaken the rally's momentum. This is a delicate handoff: from trade to taxes, from story to substance, from optimism to results. This is the fragility of the current moment."
This administration still might successfully complete the handoff, and abandoning blockade-level tariffs on Chinese goods may have bought the US government some breathing room.
But this is not the end of negotiations, it is just the beginning, and the ending has yet to be written.
