China’s leader, Xi Jinping, is betting that the U.S. economy can’t absorb a prolonged trade conflict with the world’s second-largest economy, according to people close to Beijing’s decision-making. China is holding a firm line because of its conviction, the people said, that an escalating trade war will tank markets, as it did in April after Trump announced his Liberation Day tariffs, prompting Beijing to hit back.

China expects that the prospect of another market meltdown ultimately will force Trump to negotiate at an expected summit with Xi late this month, the people said.

Beijing continued playing hardball this week, escalating the trade fight Monday by sanctioning the U.S. units of South Korean shipping company Hanwha Ocean. The move whipsawed U.S. markets on Tuesday, triggering a sharp early selloff as hopes for easing tensions faded, before major indexes partially rebounded and steadied in the afternoon.

Last week, Beijing imposed restrictions on the export of rare-earth minerals, which are vital to consumer electronics and the tech industry. Trump then threatened additional 100% tariffs on China starting Nov. 1.

Both sides have vacillated between tough talk and de-escalation in recent days, but the rhetoric took a harder turn on Tuesday. China’s Commerce Ministry accused the U.S. of “double standards” regarding tariff threats and it vowed that China would “fight to the end” in the trade dispute.

On his Truth Social platform, Trump said the U.S. is considering “terminating business” with China on cooking oil and other “elements of Trade,” because of China’s refusal to buy U.S. soybeans—a decision Beijing has said is retaliation for Trump’s own tariffs.

The stock market has remained one of the few checks on a president who has wielded executive power aggressively.

Trump frequently wields the market as a real-time barometer of his economic stewardship. He has taken to social media to trumpet record market highs, crediting his administration’s policies such as deregulation and tax cuts. Conversely, when the market has faltered, particularly in response to his aggressive trade policies, he has tended to retreat or float the prospect of new deals.

While Trump hails the strength of the U.S. economy, Chinese officials see weaknesses that would worsen during a trade war. With hiring slowing, manufacturing contracting and prices rising, many economists say the U.S. isn’t positioned to absorb another major trade fight with China. The market’s sharp negative reaction on Friday to China’s new rare-earth restrictions and the potential U.S. retaliation served as a reminder of the economic vulnerability Beijing seeks to exploit.

China’s own economy has been in a protracted downturn, weighed down by a collapsed property market, ever-rising debts and weakening consumer confidence. However, Xi is far less beholden to market swoons, even though the Chinese economy faces a precarious outlook.

Speaking to reporters at the White House on Tuesday, Trump projected a mix of his usual stated personal affinity for Xi and open confrontation when addressing the trade dispute with China. Trump framed the conflict through his relationship with the Chinese leader, whom he called a friend.

“I have a great relationship with Xi,” Trump said, before quickly adding: “But sometimes he gets testy.”

Acknowledging the severity of recent Chinese actions ranging from its new rare-earth export controls to the latest shipping-related sanctions, Trump said, “We have a lot of punches being thrown.”

He then pivoted to defend his economic strategy against fears of a market downturn, portraying the U.S. as impervious to pressure. “We are the most successful we have ever been as a country,” Trump said.

Beijing softened its tone on Sunday after Trump reacted furiously to the rare-earths restrictions, but its de-escalation appeared to be a tactical pause.

According to the people close to Beijing’s decision-making process, Xi’s hard-line strategy is based on the belief that Trump will ultimately fold and offer concessions rather than deploy Washington’s own significant leverage. This confidence was fueled, the people said, by a U.S.-China trade truce struck in May. Trump had imposed tariffs of more than 100% on Chinese products but relented after Beijing used its leverage as the world’s most important exporter of rare-earth magnets.

“It is precisely China’s belief that Trump will fold—as he appeared to do on magnets earlier this year—that has led them to massively escalate,” said Rush Doshi, a scholar at Georgetown University and the Council on Foreign Relations who previously served in the Biden administration.

U.S. Trade Representative Jamieson Greer told CNBC on Tuesday that senior officials in Washington and Beijing had held discussions about the latest trade tensions on Monday, saying both sides “will be able to work through it.”

People familiar with the matter said U.S. Ambassador to China David Perdue has been trying to arrange a phone call between Treasury Secretary Scott Bessent, who leads the U.S. negotiation team, and his Chinese counterpart, Vice Premier He Lifeng.

Attention now turns to the expected summit between Trump and Xi when both attend a gathering of Asia-Pacific leaders in South Korea later this month.

“The meeting will be the message. There will not be major breakthroughs,” said Ryan Hass, director of the China center at the Brookings Institution think tank and a former senior national-security official. “Xi will want to use the meeting to project greater stability and predictability. Trump could look for assurances on flows of rare-earth elements. They may announce an extension of the trade truce that limits tariff escalation.”

Write to Lingling Wei at Lingling.Wei@wsj.com and Gavin Bade at gavin.bade@wsj.com

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