In its latest development of the US-China trade war, the two nations decided to extend the October 2025 trade truce for two more months – until January 2027 – during the Chinese President Xi Jinping’s state visit with US leader Donald Trump last Thursday. While the time period of the extension fell shorter than market expectations – which broadly accounted for a three-to-six-month period – this still brings about some level of ‘certainty’ for investors and businesses for the remainder of 2026. It also signals that neither party is satisfied enough with the terms to enter onto a more concrete, longer-term deal as of yet. However, with the two leaders expected to meet two more times later this year, more developments around trade and the AI race are expected to come about that could potentially give market participants longer-term signals of the future pathway.
The need for a durable solution
The current truce between Beijing and Washington which unveiled in October last year, brought some level of relief from absurdly high tariffs alongside the agreement to suspend rare-earth curbs and continued purchase of US Soybeans by China. A Congressional Research Service report in July 2026 noted that Chinese goods exported to the US still face tariffs of 36.5 percent, while US goods entering China are taxed at 31 percent.
Given the current context, it is clear that any escalation from this point onwards is just too costly for both sides. While increased costs and inflation have been major concerns so far, any higher tariffs from this will squeeze margins and raise prices, dampening consumer confidence further. With mid-term elections round the corner, rising prices from current levels will only hurt any prospect of gaining votes.
And then, there’s the largely unpopular Iran war which has raised the country’s debt stock to a historic high of USD 40 Trillion! A truce collapse and any inflationary shock will only add on to this bloating debt load and limited fiscal space, putting consumers and the general economy at risk.
China too, finds itself at a crucial juncture with a number of structural issues weighing heavily on its economy with any escalation carrying sizeable costs for its participants. Weak domestic demand, sanctions on buyers of Russian oil, tensions over Taiwan and tighter measures from its major trading partners – particularly the EU – against the large surpluses run by Beijing, could trigger additional costs, dampening the economic landscape of the manufacturing giant.
However, one area the truce does not seem to slow down is the rapidly evolving AI race. While US Treasury Secretary has said that both sides had agreed to launch a communications “hotline” for notifying each other about AI safety incidents, analysts expect cooperation to remain low due to a lack of mutual trust on the technology and because neither side has expressed serious interest in slowing down development. What this means in terms of company valuations and the financial risk that runs alongside, remains unclear to predict.
How have markets reacted so far?
While markets have reacted in mix ways, the truce, for the most part, is viewed as merely a delay in progress. With prospects for a longer-term extension still unclear, China’s benchmark CSI 300 Index fell 1.3% last Thursday. Meanwhile, companies positioning themselves as alternatives to China’s dominance in the rare earths supply chain saw their shares drop, as the extension of the truce gives more room for negotiations over access to these critical minerals used in modern technologies.
Asian stocks were also seen split as markets moved to react to other forces stemming from higher interest rates, easing energy prices and rising US bond rates while investors continued to price in higher levels of uncertainty despite the announcement of the truce.
In a broad sense, mixed market movements show that while the extension of the truce signals limited policy shock in the near term, it has not indicated any prospect of future growth or certainty for investors to make longer-term bets.
What does this mean for Sri Lanka?
In terms of trade, the truce does bring some level of ‘stability’ to exporters, importers and those connected to US-China supply chains for the rest of 2026, giving more time to continue operations and amplify any diversification efforts in the meantime. While any escalation from this point onwards is mostly out of the picture right now and any concrete and durable agreement also seems to be out of reach. While the hope for a longer-term deal does exist, depending on the specifics that are expected to come about within the next few months, more short-term fixes like this can be expected even beyond 2027, as long as both parties try to enter into a deal that prioritizes what each of them want.
From a markets’ perspective, given that Sri Lanka has now received a credit rating upgrade and has shown promising progress in terms of fiscal performance over the past few years, any foreign flows to local equity or debt markets could potentially carry a considerable upside. Particularly, portfolio flows which has remained quite weak over the past few years, could see some spark in the event of foreign money coming in to the country. Given the early stages of the upgrade, any sizeable impact stemming from such financial flows will need time to materialize and is still too early to predict.