Markets Are Rallying—But This Us China Tariff Deal May Be the Last Calm Before a Shock

@K3-LAB

On May 12, 2025, the United States and China reached a surprisingly swift and significant agreement to lower tariffs—one that exceeded market expectations.

The U.S. reduced tariffs to 30%, imposing 20% on fentanyl-related products and 10% as a universal tariff. China, in turn, slashed its tariffs from over 100% to around 10%.Markets responded immediately. More than the numbers, what thrilled investors was the perception that “the worst of the U.S.–China trade war is now behind us.”Considering the high tensions between the two powers in recent years, this mood shift was not without reason.

But at K3 Lab, we see things differently.This agreement is not a sign of lasting peace, but rather a tactical pause—a form of strategic preparation ahead of a more intense confrontation. That conclusion stems from the underlying political and economic realities both countries currently face.

Why the U.S. Moved First

Before the tariff agreement, the markets were expressing deep distrust in the U.S. economy. Inflation expectations remained high, and the probability of a U.S. recession—according to decentralized prediction market Polymarket—was 65%. This showed that “a 2025 recession” was being widely priced in.

Following the tariff truce, recession odds dropped to 41% on Polymarket.Yardeni Research cut its estimate to 35%, and Moody’s chief economist Mark Zandi reduced his own projection from 60% to 45%.These shifts indicate that the tariff suspension itself helped restore market confidence in the U.S. economy.

The most telling indicator is the U.S. dollar index (DXY).In recent months, DXY had fallen sharply from 110 to 97—a sign of declining confidence in U.S. assets, and rising inflation pressure.If the U.S. were to escalate a trade war with China under these conditions, it would have invited further price shocks and destabilized domestic markets. In other words, Washington simply couldn’t afford to fight now.

Why China Agreed

China’s situation was no better.High U.S. tariffs and secondary pressure on third-party exporters had blocked China’s rerouting strategies.Its export-led growth model hit a wall, while domestic challenges—real estate debt, local government defaults, and rising youth unemployment—amplified internal stress.

Facing capital outflows and stagnating consumption, engaging in a full-scale confrontation with the U.S. would have been an immense gamble.Thus, like the U.S., China needed time.The result was a compromise: tariff cuts + a 90-day moratorium.

But what does the U.S. aim to achieve during these 90 days?The first and most urgent goal: restoring dollar strength.

1. The U.S. Needs a Strong Dollar—Fast

One of the biggest threats to the U.S. right now is inflation.The 10%+ drop in the dollar index from 110 to 97 has already pushed prices higher.At one point, even U.S. supermarket shelves were beginning to show signs of inventory stress.

Without this truce, 100%+ tariffs on Chinese goods combined with a weak dollar would have sent consumer prices skyrocketing.But now, with tariffs down to 30%, pressure on import prices has eased.And markets have responded: DXY has rebounded from 97 to 101.6 in just days.With a stronger dollar and lower tariffs, inflation will temporarily stabilize—exactly the outcome Washington needed.

2. Washington Needs to Finalize Its Supply Chain Deals

Beyond inflation, this 90-day period is just as much about geopolitical signaling as it is about trade.The real pressure now is on U.S. allies and supply chain partners.

In Japan, Yomiuri Shimbun reported concerns that “Japan may lose priority status if the U.S. accelerates direct talks with China.”South Korea faces a similar dilemma.The message to countries like Vietnam and Taiwan is clear: “Don’t fall behind. Get on board now, or get sidelined.”

If the U.S. escalates tariffs again, a lack of alternatives to Chinese goods could repeat the recent episode of rising prices and empty shelves.That’s why securing agreements with allied nations—Japan, Korea, Taiwan, Vietnam—is now a top priority.And the deal with China? It’s likely a calculated show of diplomacy designed to push these allies to finalize their own negotiations.

3. Washington Is Testing Beijing's Promise of Market Opening

Donald Trump recently stated that he “wants a beautiful arrangement” with China—one where China consumes more and the U.S. produces more.That vision requires opening China’s consumer and financial markets, allowing American firms to share in China’s domestic growth.

China has verbally agreed to market liberalization during this 90-day period. But is it believable?

We remain skeptical. In China, financial markets are tools of political control. Opening them now would risk losing grip over capital flows, especially when the U.S. is accelerating while China’s growth is slipping.

Moreover, full opening would likely trigger capital flight—something Beijing cannot afford during a slowdown. Even in consumption, trust in U.S. intentions is weak, and China is more likely to opt for gradual, conditional liberalization.

Bottom line? It’s highly unlikely China will deliver real market opening in 90 days. And that means: once the U.S. has finished its prep work—supply chain deals, rate cuts, dollar stabilization—it may return with far greater pressure on China.

4. A Word to Investors

In a May 6 K3 Lab post titled “The Sudden Won Surge—America's Power Play Has Just Begun,”we noted that short-term rebounds were possible if tariff diplomacy replaced confrontation—and that is exactly what happened. China-driven liquidity and temporary U.S. dollar strength could sustain the rally in the short term.

But this is likely a calm before a deeper storm.

As we wrote before:

• The U.S. must complete supply chain deals with allies before clashing with China—likely within this 90-day window.

• It must also ease rates to prepare the economy for any downturn that follows a renewed conflict.

  
  

When that groundwork is complete, Washington will act.That moment—when the U.S. is “ready”—could mark the top of the market, and the beginning of the next great drawdown.

So yes, this rally can be traded.But it is not a time to chase risk blindly. Now is the time to cash in—not double down.