How U.S.-China Flare-up Could Impact AI’s Advance

After China threatened to materially widen the scope of rare-earth export restrictions, U.S. President Donald Trump responded with threats of additional large tariffs. U.S. equities dipped about 3% in response, marking the largest one-day decline for the S&P 500 since April.

Equity markets can often overreact to negative news, especially after a period of extended calm. These types of moves can have outsized short-term market impacts due to technical factors like crowded investor positioning. More broadly, the U.S. tariff threats highlight ongoing uncertainty around tariffs and U.S.-China relations, including broader economic impacts, ongoing legal challenges, and the potential for uneven sector-based impacts down the road. Financial markets are likely to remain attuned to U.S.-China headlines — even without material policy changes — as the issue spans both the broader macro backdrop and the artificial intelligence (AI) narrative. For instance, if China follows through on its rare-earth threats, it could materially restrict key components in semiconductor-related supply chains. This, in turn, could weigh on the AI adoption narrative and broader equity investor sentiment, given how central the AI-related theme has been to recent equity market gains. Overall, this remains more of a risk scenario in our view, but it’s something we are closely tracking. Outside the U.S., domestic political developments continued to draw attention throughout the week. Similar to early September, France and Japan once again shared the spotlight. Though different in many respects, both countries face political challenges in managing fiscal policy amid elevated debt levels and rising long-end government bond yields — without a strong governing majority for the parties in power.

With France on its fifth prime minister in two years, the political situation remains quite uncertain with the 2026 budget a near-term priority. The legislature remains divided across three major camps, with growing fiscal and debt-related concerns from the investor community. While French equities have performed well in 2025 alongside the rest of Europe, the political headwinds have been more impactful in the bond market. The spread of France’s 10-year government bond yield over Germany’s is near 10-year highs (roughly 80 basis points). Plus, the France 10-year yield is now roughly in line with Italy’s, despite typically trading more than 100 basis points lower over the last decade.

Meanwhile, Japan’s political uncertainty has declined but only modestly with possible re-acceleration on the horizon. Financial markets responded to Sanae Takaichi’s surprise win in the Oct. 4 leadership election of the Liberal Democratic Party (LDP), positioning her to become the country’s first female prime minister. The result led to initial equity gains, yen weakening, and steepening of the yield curve. Takaichi favors looser fiscal policy and targeted investment in key industries (defense, technology, etc.). However, enacting her policy priorities remains challenging, as the LDP lacks an outright majority in either house of parliament, meaning Takaichi will have to work with opposition parties to assume the prime minister role and pass legislation. This issue intensified after late-week news that Komeito, a smaller party and longtime LDP ally, announced it would leave the coalition with the LDP. Entering the prime minister seat will be even tougher for Takaichi in the near term, with heightened focus ahead of U.S. President Trump’s upcoming Japan visit in late October. By the end of the week, Japan equities were up more than 2% in local currency terms, the yen weakened about 2.5% against the U.S. dollar, and interest rates edged higher.

What to Watch for This Week

In response to China’s newly announced export controls, President Trump cast doubt about proceeding with a planned meeting with President Xi in the coming weeks and later announced a 100% additional China tariff on Friday night. Financial markets will assess the risk of a further rise in U.S.-China tensions in the near future, with a few key implementation-related deadlines set for early November.

The U.S. government shutdown continues, adding to the list of delayed economic data releases, such as September inflation and retail sales data. Third-quarter earnings season begins on Tuesday, with the usual cohort of large banks scheduled to release earnings, including JPMorgan (JPM), Citigroup ©, and Wells Fargo (WFC). Earnings expectations for the third quarter have been relatively stable over the past three months, with upward revisions in tech-related sectors and financials helping offset negative revisions in most other sectors. This differs from the traditional pattern of downward revisions (a few percentage points in the months leading into earnings season) followed by upside surprises when the companies actually report earnings. According to consensus expectations, aggregate earnings growth of about 8% year-over-year is expected for the S&P 500. Key earnings season watchpoints include AI-related demand and investment plans, as well as tariff-related impacts. Outside the U.S., the global economic data calendar is light, with inflation reports from Europe and China. France and Japan political-related developments will likely remain in the headlines.

Key Tactical Calls

Tilt to equities and real assets. We maintain a preference for equities and real assets over fixed income, expressed through tactical overweights to global equities and listed infrastructure. Within fixed income, we prefer high yield over more duration-sensitive segments of the market.

Earnings resilience. Easier monetary policy and fiscal stimulus help reduce downside economic risk, and global corporate earnings continue to grow.

Cautiously constructive. While our baseline is constructive, key downside risks we’re watching include a pronounced labor market downturn, sticky inflation, and a sustained breakout in yields.

Source: Bloomberg for data, news developments and schedule of economic releases. Data as of Oct. 10, 2025.

Peter Wilke, Senior Vice President – Head of Tactical Asset Allocation

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