U.S.-China Tariff Truce Boosts Global Markets, Eases Recession Risk

The recent agreement between the U.S. and China to pause most tariffs for 90 days has significantly eased trade tensions, providing a much-needed respite for global markets. This tariff truce has led to a surge in risk-taking on Wall Street, resulting in a Treasury selloff that has boosted yields. The U.S. has agreed to reduce tariffs on Chinese imports to 30% from 145%, while China has committed to lowering duties on U.S. imports to 10% from 125%. This de-escalation in the trade conflict has reduced the likelihood of a recession, giving the Federal Reserve more flexibility in adjusting interest rates.

The easing of tariff pressures has lowered inflation risks, which in turn minimizes growth risks. This shift allows the Fed to consider cutting rates, potentially as early as July, rather than June. The reduction in tariffs is seen as a positive development for risk appetite, as it signals a willingness from both countries to engage in further negotiations and a conciliatory approach to trade discussions with other nations.

The tariff truce has also had a positive impact on global markets, with investors expressing relief and optimism. This has led to a surge in stocks, the dollar, and bond yields. The agreement has defused trade tensions between the world's two largest economies, dramatically reducing the tail risks that investors had priced into world markets. Many economists have raised their growth forecasts for both the U.S. and China, although the projected stimulus from Beijing is expected to be lower.

The Federal Reserve's cautious approach to policymaking has been highlighted by its decision to keep interest rates on hold despite rising inflation risks. While other major central banks have been cutting rates to cushion the blow from the looming growth slowdown, the Fed has maintained a patient stance. This cautious approach runs the risk of leaving the Fed behind the curve, as the costs of waiting to resume its easing cycle could neutralize more aggressive moves later.

The Fed's stance is more reasonable when viewed through an inflation lens, as U.S. inflation expectations are significantly higher than those elsewhere. The incoming import tariffs have led consumers to brace for a steep rise in prices later this year. However, the recent de-escalation in U.S.-Sino trade tensions may shift these expectations. Even after trade agreements are reached, America's average effective tariffs will still be the highest in decades, and more than 75% of companies surveyed by the Fed have stated they will be passing cost increases along to consumers.

The tariff truce has also had a positive impact on global geopolitical tensions, with signs of de-escalation in actual military conflicts. This has provided additional reasons for investors to be relieved and even cheerful. The thaw in U.S.-Sino trade tensions is not the only reason for investors' optimism, as global geopolitical tensions appear to be cooling on multiple fronts.

In conclusion, the tariff truce between the U.S. and China has provided a significant boost to global markets, easing trade tensions and reducing the risk of a recession. The Federal Reserve now has more room to cut rates, although its cautious approach to policymaking may leave it behind the curve. The positive impact of the tariff truce on global geopolitical tensions has also provided additional reasons for investor optimism.