North Korean worries saw markets trade in a risk-off fashion in the past week, as sabre rattling from Pyongyang in the wake of new sanctions was met by threats of ‘Fire and Fury’ coming from the Trump White House.
Government bond yields rallied during the week, with credit spreads pushing wider, though price action in equity markets was relatively orderly and it was interesting to observe that price action in assets, which would typically expect to be most affected by these concerns (such as the Korean stock market) were far from exceptional. It strikes us that the threat of war on the Korean peninsula has been overstated in the Western media and looking at news flow from a Chinese perspective, we would see recent developments in a rather different light.
Firstly we would note that Kim Jong-un’s principal interest in acquiring a nuclear capability has been to ensure the survival of his regime (having witnessed how Gaddafi and other non-compliant tyrants have been summarily removed from power in recent years). Having achieved this outcome, the North has nothing to gain and everything to lose in an outright conflict. At the same time, this week’s rhetoric shows how upset the regime is at the latest sanctions, which will hurt the economy and they feel aggrieved that China has agreed to this. From a Chinese perspective, Beijing continues to disengage in its ties with the North, having accelerated its pivot towards South Korea (which is now a huge trading partner) since Kim wiped out the pro-Chinese members of his family after he came to power. There is now outright disdain for Kim in China, where media commonly refer to him as Fatty Kim the Third. This fat shaming seems to have damaged Kim’s feelings (and Xi even agreed that use of this name should be banned) and consequently, by trying to target Guam, it appears Kim is trying to re-establish common cause with Beijing, who have been increasingly irritated by the build-up of US military presence on the island. However, bringing this to where we find ourselves now, it seems appropriate to believe that a sense of stalemate should resume, as recent comments and claims leave little room for further escalation towards a conflict, which nobody actually wants and from which nobody will benefit. Consequently, we feel that market moves of the past week are likely to be reversed and calm to be restored over the next couple of weeks, as investors await the monetary policy discussions around Jackson Hole at the end of the month.
Looking ahead, market attention today will be on the US consumer price inflation (CPI) report, where a rise in tobacco taxes may see a reversal in the recent trend towards softer core inflation prints. Doves on the FOMC have highlighted recent softer inflation prints, but in the wake of last week’s robust jobs report, as long as inflation remains close to target, we remain convinced that the Federal Reserve (Fed) will continue to normalise interest rates towards 2.5%, tightening policy once per quarter on a gradual path. In our view, this could lead to a renewal of the reflation trade before the end of the year, if markets become less sceptical on the Fed, though we would be surprised if this occurs for the next few weeks.
At the end of the month, the meetings at Jackson Hole are cited as a potentially important moment for monetary policy deliberations. However, we anticipate speeches will follow more academic topics this year and with the key European Central Bank meeting at the start of September, we doubt Mario Draghi will have too much he wants to give away. Otherwise, we feel that following the action in the past week, August should return to being a relatively uneventful month. We believe that this Korea wobble may be short lived in the absence of new news and should equities rebound to new highs, this will continue to give fresh impetus to carry trades. At the same time, with market liquidity relatively thin, moves at this time of year can be exaggerated and with volatility having been so low for so long, this raises the risk that any catalyst could provoke a deeper move. However, we are not currently convinced that events in Korea will be this catalyst and are inclined to hope that the Tweeting Twits entrusted with running the planet will (eventually) learn to play nicely and kiss and make up.