Straits Financial Chief Economist Commentary – February 2025

Summary:

• Since Trump took office, he has continuously rolled out policies on high frequencies. But his policies have also shown inconsistencies, contradictions, and dramatic shift.  These actions have led to short-term instability without significantly affecting the U.S., the global economy, or capital markets.

• The impact of rising tariffs on China’s exports is expected to be between $30 billion and $40 billion, which is limited compared to nearly trillion U.S trade deficits and China’s trade surplus. Since 2018 trade war under Trump 1.0, the structure of US import supply chain has changed significantly. U.S importers are increasingly purchasing goods from ASEAN countries, Mexico and the EU instead of directly importing from China. Simultaneously, Chinese companies are increasing their investment and production in these regions, leading to a significant rise in exports from these regions. As a result, total U.S imports and China exports were not affected by the trade war.

• More importantly, the U.S dependence on imported goods as a percentage of its total domestic goods consumption remains very high and stable. Additionally labor costs have grown much faster than most countries in the world over the past several years.

• There is no doubt that Trump wants to reduce the U.S. trade deficit and bring manufacturing back to America. However, he aims to achieve this without causing economic hardships for Americans, such as increased inflation, a recession, or a major stock market sell-off. In this context, his policy options are significantly limited. Following his inauguration, his approval rating has declined, making it even more difficult for him to push through additional policies in the future.

• The recent success of the Deep Seek AI model in China will significantly weaken the narrative of AI in the U.S. stock market but will boost investor confidence and risk appetite in Chinese stocks.

• We are optimistic about the overall chances of a rebound in Chinese A and H shares. We believe the market will gradually recover from concerns over Trump’s foreign trade pressure on China and experience a relief rally to regain the losses from the beginning of the year. Additionally, China has recently made breakthroughs in new technologies, such as AI and robotics-related sectors, which are expected to rise further.

• Our view on U.S. stocks has shifted from optimism to neutrality and caution. Although U.S. stocks still benefit from market optimism and the inflow of retail funds, Trump's optimistic 'honeymoon period' appears to be coming to an end.

• Despite potential economic headwinds, our outlook on gold remains positive.

Previous Views:

The market may overestimate the negative impact of Trump’s trade policy on China and be overly cautious about rising tariffs. We expect domestic liquidity and economic indicators to improve in the near term. While A-shares may have limited potential upside, their downside risk is also constrained. A and H share investors are advised to buy on consolidations and focus on small-cap and thematic tech stocks. Aside from gold, we do not see significant growth potential in other commodities.

Views in February:

I. There is no need to overly worry about the impact of Trump's tariffs on China's exports next year

Since taking office on 20th January, Trump has continuously introduced a series of high-density policies that have impacted global financial markets and shaped media opinion. In addition to his consistently deliberate tough stance, his policies have also exhibited inconsistencies, contradictions, and even dramatic shifts, further exacerbating volatility in the stock, foreign exchange, and bond markets. However, overall, apart from the abolition of several U.S. government agencies previously mentioned by Trump or Musk, most of his policies have not been effectively implemented and have had little substantive impact on the U.S. and global economy or capital markets.

1.      Trump’s trade policy

Trump's foreign tariff and trade policy is undoubtedly the market's primary concern. In early February, Trump announced a 25% tariff on Mexico and Canada but quickly reached a compromise with both governments, postponing the tariffs for a month. At the same time, he declared a 10% tariff increase on imports from China and threatened to raise tariffs on EU imports. However, Trump’s tariff policy has not exceeded previous market expectations. For now, his tariffs remain largely a rhetorical threat, except in the case of China.

According to U.S. Customs statistics, the United States imported $428.9 billion worth of goods from China in 2024, and the actual impact of the tariff increase is expected to be between $30 billion and $40 billion. The overall impact on both the Chinese and U.S. economies is limited.

From the U.S. perspective, the proportion of goods imported from China relative to total U.S. imports declined to 13.3% in 2024, a sharp drop from 21.1% in 2018 under Trump 1.0. At the same time, due to the impact of the U.S.-China trade war in 2018, the overall structure of U.S. import logistics has changed significantly. U.S. importers are increasingly sourcing goods from ASEAN countries, Mexico, and the EU instead of directly importing from China. Meanwhile, Chinese companies have increased their investments and production in these regions, leading to a notable rise in exports to these areas.

In addition, and more importantly, the share of imported goods in total U.S. consumption has not declined significantly.

As shown in Figure 2, excluding energy products such as crude oil and gasoline, U.S. goods imports have fluctuated between 50% and 55% of total domestic consumption of non-energy goods. This indicates that the United States' dependence on imports for overall goods consumption has remained relatively stable, with significant declines occurring only during the 2009 financial crisis and the 2020 COVID-19 pandemic.

As long as the U.S. economy maintains steady growth, its dependence on imported goods remains stable, even during Trump's first term. Therefore, it can be expected that the overall impact on China's exports and trade surplus will not be significant if Trump 2.0 only raises tariffs on China to a limited extent, rather than imposing sharp tariff increases on all major trading partners, including the EU, Mexico, and ASEAN.

In fact, since 2018, China's trade surplus with Mexico and ASEAN countries has expanded significantly. Its trade surplus with Mexico increased from $30.1 billion in 2018 to $71.1 billion in 2024, while its surplus with ASEAN rose from $52.4 billion in 2018 to $191.1 billion in 2024 (Figure 3).

Excessive self-restraint would significantly weaken Trump's negotiation strategy. There is no doubt that the Trump 2.0 administration aims to substantially reduce the U.S. trade deficit. However, given that the cost of producing and manufacturing goods in the United States is much higher than that of its international peers, and its dependence on imported goods remains above 50%, it is unrealistic to expect a significant reduction in the trade deficit solely by raising tariffs. More importantly, the Trump administration seeks to ensure that Americans do not incur any costs in the process, which constrains its policy options. For instance, the administration is reluctant to allow inflation on consumer goods to rise sharply due to increased tariffs. Simultaneously, it cannot accept a substantial rise in Treasury bond yields driven by escalating inflation expectations, as this would elevate the U.S. government’s interest payments. Furthermore, the administration cannot afford a significant downturn in the U.S stock market because of its policies.

Given these numerous constraints, Trump's threats regarding a foreign trade war have diminished in strength, and he must closely monitor the policy reactions of the U.S. equity market. Currently, U.S. stocks are highly valued and susceptible to negative impacts, which will complicate Trump's ability to implement his threat strategy. Over time, his counterparts will gain a clearer understanding of his limitations, making them less likely to yield to his tactics.

2. Trump’s domestic policy may also face a dilemma

Compared to the foreign trade policy, Trump's implementation of domestic policy is currently smoother, primarily due to the GOP's majority in both the Senate and the House of Representatives. Consequently, while executive orders on immigration may encounter legal challenges in Democratic states, overall policy progress has remained relatively stable. However, Trump's domestic policies have yet to tackle the most challenging issues. These include significantly reducing the U.S. fiscal deficit, effectively deporting illegal immigrants, and identifying strategies to lower yields on U.S. Treasury bonds to decrease government financing costs.

Elon Musk has made numerous public appearances and announced several initiatives over the past two weeks, including eliminating government institutions such as the Diversity, Equity, and Inclusion (DEI) departments and the United States Agency for International Development (USAID). These actions are unlikely to adversely affect the lives of ordinary Americans, at least in the short term, resulting in minimal public resistance. However, these institutions did not have significant fiscal outlays, totaling only several dozen billion U.S. dollars, which is still far from Musk's goal of reducing fiscal expenditures by $1 trillion annually

If Trump or Musk continues to advance their agendas, the resulting decrease in funding for larger and more significant projects will inevitably affect the income and welfare of everyday Americans, leading to heightened resistance. For instance, Musk has indicated that he is contemplating dismantling the U.S. Department of Education, which would have a far greater impact on ordinary citizens and the economy than the previous eliminations of DEI and USAID.

In the fiscal year 2024, the total expenditures of the U.S. Department of Education reached $268.4 billion, with $160.7 billion designated for the Federal Student Aid Office. Since 2020, this substantial increase in funding has provided financial assistance to numerous low- and middle-income American families with student loans, while also helping many low-income students manage escalating tuition costs. If these aid programs were to be reduced, it would impose significant financial strain on a considerable number of low- and middle-income families with student loans in the U.S.

Additionally, a significant portion of the Department's budget is allocated to supporting vital scientific research and funding educational programs for individuals with physical and intellectual disabilities in the U.S.

Beyond that, Trump's plan to reform the U.S. healthcare system, including Medicaid and the Affordable Care Act (ACA), may provoke widespread discontent. Earlier, the Trump administration announced its intention to begin cutting federal healthcare spending and to limit or even eliminate the ACA, which was established under President Obama, in the upcoming fiscal year. This plan would require Americans to pay more for health care through private insurance, to use the resulting savings to fund promised tax cuts. However, current polling data indicates that a majority of voters, both Democrats and Republicans, oppose this policy shift.

The most critical issue is that the continued deepening of spending cuts may not only lead to increased dissatisfaction among more Americans whose benefits are affected, but it may also result in a slowdown in consumer spending and economic growth in the U.S., ultimately contributing to a decline in support for the Trump administration.

Figure 5. Trump’s Approve and Disapprove rate

According to data from a U.S. polling website, Trump's disapproval rating increased from 41.5% to 44.4% in the first 16 days following his inauguration, while his approval rating decreased from 49.7% to 49% (Figure 5). That indicates that the Trump administration does not have significant leeway to make major errors regarding radical policy changes.

Of course, it is still too early to definitively assess the success or failure of Trump's overall domestic and foreign policies. However, it is reasonable to conclude that the internal and external challenges and pressures confronting the Trump administration will inevitably continue to escalate in the future.

II. President Trump is relying on rhetoric to lower interest rates

In the near term, the U.S economy can still maintain a good growth momentum, mainly due to the rising U.S fiscal expenditure in 4Q2024. The U.S fiscal deficit in the whole Q4 (also Q1 of fiscal year 2025) was as high as $710.9 billion, mainly affected by the Biden administration's rising spending before he left office, which also made 4Q2024, surpassing 4Q2020 as the highest fiscal deficit quarter in the U.S history (Figure 6). As fiscal expenditure has a significant lagging pulling effect on economic growth, the overall U.S economy is expected to maintain a good growth level in the first quarter of this year.

However, this situation could also create another problem: the Federal Reserve may need to suspend rate cuts as economic data remains strong. Simultaneously, "the Trump trade" attracted a large number of funds flows into the stock market, the net purchases of exchange-traded funds (ETFs) in U.S. stocks reaching a record $1.12 trillion in 2024. Notably, a net inflow of $414 billion was recorded in just three months in Q4 alone (Figure 7). These conditions have contributed to persistently high yields on U.S. Treasury securities, while significantly increasing pressure on fiscal interest expenses. Recently, President Trump expressed his desire for the market to keep yields on 10-year Treasury bonds low, rather than relying on the Federal Reserve to cut rates. His comments aim to guide long-term interest rates on U.S.

Treasury bonds downward, thereby reducing borrowing costs for American businesses and residents. However, we believe that unless the U.S. can significantly improve its fiscal balance, it will be challenging to lower long-term Treasury bond interest rates quickly, especially given the Fed's failure to cut interest rates. Moreover, substantial cuts in fiscal spending could lead to an economic downturn and a decline in support for the Trump administration. Therefore, it is more likely that Trump will continue to use rhetoric in the future to signal the market to lower interest rates. This approach aligns with President Trump's policy logic, which seeks to achieve tangible benefits "without incurring additional costs”.

Currently, due to the limitation of the debt ceiling, the net issuance of U.S Treasury bonds has been stopped, so President Trump can indeed suppress the rise of long-term treasury bond yields through verbal intervention in the short term, but as late as the middle of this year, the debt ceiling will inevitably be raised, and the pressure on the issuance and financing of U.S Treasury debts will increase sharply at that time. At that time, if there is no policy cooperation from the Fed to cut rates or even restart QE, the verbal intervention of the President alone will be powerless to control the rise of interest rates.

III. The DeepSeek case may negatively impact the AI narratives of the U.S Stock Market

Trump's impact on China's exports has been less significant than the market previously anticipated. Additionally, the remarkable success of China's DeepSeek AI model has further bolstered confidence in the domestic market and economy. Given China's vast population and market scale, Chinese enterprises have historically held advantages in technological application development, supply chain management, and marketing, while being relatively weaker in the research and development of foundational original technologies. Therefore, as long as Chinese enterprises can approach or even match the United States in the realm of fundamental AI technology, they are expected to leverage these strengths to swiftly secure a dominant position in the market. This undoubtedly expands the potential for future growth among Chinese enterprises in related sectors.

However, it is also true that the advantages of Chinese companies in technological applications, supply chain management, and marketing are often derived from intense competition. Consequently, a significant number of Chinese enterprises have rapidly entered related fields, leading to a state of fierce competition and potential losses in the AI application sector before establishing a stable profit model. From the perspective of stock investment, aside from a few companies with strong competitive advantages in marketing channels, most firms involved in AI downstream applications are likely to incur losses.

From the perspective of application fields, the role of AI in replacing labor on the production side is likely to be realized sooner. For instance, AI can be utilized to write and create various texts and multimedia, significantly reducing human capital costs. However, from the consumer demand perspective, the scenario of AI generating new consumer demand remains relatively unclear and may require years of ongoing exploration. From this point of view, the short-term economic impact of AI is likely to bring more deflationary pressure, rather than inflation, which also means that the overall market return on investment caused by AI in the short term is likely to decline rather than rise. Therefore, the market's high enthusiasm for AI is likely to also contain investment risks, especially for those large-capitalization technology stocks in the U.S based on high investment return expectations.

Although in the short term, U.S retail investor fund flows may continue to flow into U.S stocks, related stocks may not fall further, or even rebound or hit a new high. But in the medium term, we believe that the emergence of DeepSeek may constitute a disruption to the market narrative related to the AI concept of U.S stocks in this round. Of course, DeepSeek alone is unlikely to cause significant disruption to the US stock market's AI narrative This opens up the possibility that, in the future, more companies in China and other countries will be able to use lower-cost AI models to develop applications that rival those of leading U.S AI firms. As a result, AI competition will likely shift from focusing on chips and big models to more downstream areas, such as application software and customer acquisition channels. This shift could lead to more intense competition based on low costs or even negative cash flows, negatively impacting the trends of related stocks.

IV. Market strategy

Our outlook on U.S. stocks has shifted from optimistic to neutral and cautious. While U.S. stocks continue to benefit from market optimism and chasing up retail funds, we believe that Trump's optimistic “honeymoon period” tends to an end. Although we believe that the actual impact of tariff policies will not be large, Trump's tax cuts and deregulation policies are also difficult to fully implement at this time.

We are optimistic about the overall chance of a rebound in Chinese A and H shares. We believe that the market will gradually recover from the nervousness about Trump’s foreign trade pressure on China, and the market will have a relief rally to take back the decline at the beginning of the year. Although the main market indexes still need more domestic favorable policies and optimistic economic data to further rise or even break through the resistance level of last year’s peak, the rebound in trading activity and risk appetite in the overall market is conducive to the development of the stock market, especially with the new technologies that China has made some breakthroughs recently, such as AI and robot-related concept sectors, which are expected to see further growth.

For commodities, we believe that gold will remain strong because after Trump takes office, whether it is the intensification of contradictions and struggles with the so-called deep state in the U.S, or the fact that he may continue to create new international geopolitical uncertainties, it will drive global investors and even central banks and governments to increase their gold holdings.