The U.S. and China have agreed to pause the bulk of their tariff policies against one another for 90 days, sending a jolt of optimism through the banking sector and its investors.
The temporary truce was struck over the weekend and announced on Monday, causing stocks to rally and credit spreads to tighten on the belief that an economic calamity had been avoided, at least in the near term.
The KBW Nasdaq Bank Index was up more than 4.5% on the day, beating the S&P 500, which was up 2.6%, and even the tech-heavy Nasdaq, which was up 4.2%.
"Clearly it's a positive," said John Buran, CEO of New York-based Flushing Bank. "It's providing a certain level of stability, and maybe indications of a more manageable level of tariffs on a go-forward basis."
Even so, other parts of the financial sector were less moved by the detente. Peter Earle, director of economics and economic research at the American Institute of Economic Research, pointed to yields on 10-year Treasury bonds rising faster than those on 3-month bills as a sign of shaky confidence.
"There's a lot of skepticism in the bond market about what this new information actually means and how durable it is," Earle said. "Investors are wary of locking in capital at lower yields given the way Trump has done this. The potential for reignition of trade friction is very high. This can all be reversed with a single tweet."
As a result of the truce, the U.S. will lower the import levy on Chinese goods from more than 145% to 10%, matching the rate applied to most other countries last month. With sectoral tariffs on steel and pharmaceuticals, as well as fentanyl-related policies, the effective rate against China is between 30% and 35%. This brings the aggregate weighted average tariff down from roughly 24% to approximately 15%, according to analysis from UBS Investment Bank.
The remaining tariff levels are well above where they were before April 2, when President Donald Trump rolled out his sweeping "Liberation Day" trade policy, exceeding even the most extreme forecasts that preceded the announcement.
Michael Redmond, a U.S. policy economist with Medley Global Advisors, said the prior level of tariffs were effectively embargoes for more than half of Chinese exports to the U.S., too large for many importers to absorb or viably pass on to customers. If those levy rates had remained, he said, they would have weighed heavily on global supply chains and had a devastating impact on the U.S. economy.
Under the truce — which could be a template for a permanent deal — firms should be able to take on the higher costs, Redmond said, noting that banks could play a role in facilitating the transition to higher import costs.
"Some smaller businesses that didn't have the cash flow to absorb a large tariff hike like they were expecting, now if it's something that's uncomfortably high but manageable they might borrow," he said. "It might make sense to draw down on their credit lines to pay that import bill."
China, meanwhile, will lower its tariffs against the U.S. from 125% to 10%. This easing is particularly important for the U.S. agriculture industry and the banks that support it.
Mark Scanlan, senior vice president of agriculture and rural policy for the Independent Community Bankers America, said the prior rate effectively barred American farmers from China, the third largest market for U.S. agricultural exports. With overall exports accounting for 20% of U.S. agricultural output, the trade barrier has depressed commodity prices and hindered borrowers' abilities to repay their lenders — more than 80% of which are community banks.
Scanlan said Monday's announcement was a positive for ag banking and potentially a sign of further de-escalation to come. He added that many ICBA members hope the ongoing trade negotiations will ultimately expand their export opportunities to China — as part of the Trump administration's push for balanced trade — but the longer the process drags out, the more damage will be wrought on U.S. farmers and, by extension, their banks.
"We hope that, as things move forward, both sides will come to an agreement and the ag sector doesn't suffer long-term harm," he said. "If it goes on for a long time, you can lose market share to other countries who would be willing to sell the same products."
Scanlan said banks have worked with farmers who have fallen behind on payments and are exploring new ways to do so. If the commodity price disruption continues, though, he said it could put pressure on lawmakers to issue direct aid to producers to help them offset their losses and pay down their debts.
No such relief is being considered for small businesses, but the impact of the new global tariff regime has had an outsize impact on Main Street, said Molly Day, vice president of public affairs for the National Association of Small Businesses. According to a survey released by the group last week, 40% of small businesses source goods from outside the U.S. but more than half have been impacted, either directly or indirectly, by supply chain disruptions.
As a result of these uncertainties, Day said 40% of small businesses are having a harder time accessing the credit they need, up from the long-term average of 34%. She added that, anecdotally, many business owners have said they are reluctant to seek new loans until there is more certainty about the economic outlook.
"I suspect loan demand is down because there is such high economic uncertainty. That's actually the number one challenge to small businesses today and it's higher than it's been in years," Day said. "When things are like this, people aren't really eager to take on new debt because who knows what's around the corner."
Monetary policy outlook
Should the tariff agreement help stave off sharp economic decline in the U.S., it could shift the Federal Reserve's approach to monetary policy.
Last week, Fed Chair
Based on this judgment, the Fed has committed to holding off on changing interest rates until it sees a clear sign of movement on prices or employment.
"We have a situation where the risks to higher inflation and higher unemployment have both gone up, as we noted in our statement, and we've got to monitor both of those," Powell said. "We actually have a potential situation where there may be a trade-off or tension between the two."
But if the downside risks to the economy wane, that would leave inflation as the primary concern, Redmond said.
"Now that it is getting plausible that costs could be passed along to consumers, we're shifting more toward an inflationary dynamic that keeps the Federal Reserve on hold for longer rather than a real severe economic crunch from such high tariff levels," he said.
As of Friday, market participants were broadly expecting the Fed to cut rates two or three times before the end of the year, according to the CME Group's Fed Watch tool, which tracks derivatives contracts tied to the federal funds rate. Nearly 90% of contracts in the space anticipate at least two cuts, with 60% calling for three or more.
Some analysts have been calling for no cuts since Trump's tariff announcement last month. One of those groups, LH Meyer/Monetary Policy Analytics, said Monday's trade agreement bolstered their call.
"Even with this reprieve, tariffs are much higher than they were, so the outlook still involves tariff raising near-term inflation well above 2%. What this reprieve does is reduce the likelihood that we'll see a deterioration in the labor market severe enough for the FOMC to ease despite concerns about elevated inflation," the firm wrote in a note. "We saw little chance of this happening in the very near term before this news, and now it's even less likely."
In theory, an uptick in inflation would call for higher rates, but some Fed officials — including Gov. Chris Waller — have argued for
Powell and other Fed officials have pledged to be data-dependent on their monetary policy adjustments. Earle said this means, for better or worse, the Fed will not adjust monetary policy preemptively, but will instead react to economic developments after they play out.
Earle added that even with the trade agreement in place between the U.S. and China, the threat of the economy retracting and inflation rising simultaneously — a dynamic referred to as "stagflation" — cannot be ruled out entirely. He argued that, given the potential outcomes, the central bank should be careful not to delay its response longer than it has to.
"There's a higher risk of miscalibration — stimulus is too late, too hawkish, too long — and that's been a hallmark of the Powell Fed," Earle said. "They opened up floodgates tremendously during COVID, they waited too long to raise rates then when they did raise rates, they did four jumbo hikes that destabilized a corner of the regional banking market with SVB.
"They've been reactive for a while," Earle added. "That raises the possibility that we may again see a misfiring of policy."
Nathan Place contributed to this report.
