Who has the upper hand in financial markets, the US or China?

In the wake of President Xi Jinping's visit to Washington, it becomes evident that China has emerged as the stronger nation from the tariff shock. China's exports have surged by 25% annually, pushing its trade surplus to an impressive US$119 billion, potentially surpassing last year's record of US$1.2 trillion. Furthermore, China's surplus with the US has increased by 44% to US$29 billion, marking the widest gap since Donald Trump took office.

China's weaponization of rare earths has also demonstrated its ability to cause significant disruption in the global economy.

However, when examining financial markets, the comparison between the US and China becomes less straightforward. The US holds nearly two-thirds of the MSCI All-Country World Index market capitalization and commands 40% of the global bond market. Moreover, the dollar remains the world's foremost reserve currency, and America boasts the deepest, most liquid, and most transparent capital markets.

Yet, current circumstances present unprecedented challenges. President Trump's erratic decision-making has shaken confidence in US Treasury bonds and the dollar, making them riskier assets rather than safe choices. Norway's sovereign wealth fund, the world's largest, recently reduced its government bond holdings due to concerns about sovereign debt volatility in the US.

This shift in perception signifies a reevaluation of sovereign risk, particularly in the United States.

China's financial markets have exhibited resilience amid the global turbulence. Firstly, Chinese government bonds have defied the sharp sell-off in global sovereign debt markets. While the US 10-year yield surged to a five-year high of 5%, China's yield dropped to 1.6%, just above its all-time low. Chinese government debt returned nearly 3% this year, excluding currency fluctuations, according to Bloomberg data.

Secondly, China's yuan has reached its strongest level against the dollar since January 2023, despite the country's weak domestic economy and the recent greenback rally. China's massive trade surplus and relative resilience to the energy shock have bolstered the yuan, with Gavekal predicting significant potential for further appreciation due to the country's substantial trade surplus.

Thirdly, China's competitive advantages in artificial intelligence (AI) provide investors with a hedge against potential threats to the US AI infrastructure development. Bank of America highlights that China's AI ecosystem is less correlated to the US AI capital expenditure cycle, while JPMorgan believes China's internet stocks benefit from demand for AI monetization and application-layer exposure.

The backlash against new data center construction in the US and calls for stricter AI regulation further emphasize the case for diversifying into Chinese tech stocks.

However, one must consider the sources of China's market resilience. The bond market's outperformance is attributed to the persistent weakness of the domestic economy and expectations of further monetary easing. Retail sales growth has remained below 1% for five consecutive months, an unprecedented period outside the pandemic years.

Additionally, China's export-driven AI boom highlights the economy's unbalanced nature. The economy's vulnerabilities, combined with the stability of its debt market, give China a more reassuring position compared to the US, where the Federal Reserve is raising interest rates due to robust growth. Services and manufacturing output expanded at the fastest pace in five years this month.