The following excerpt is from an article that originally appeared on Zero Hedge
For the first time in four years, the credit market sees more risk of a South Korean sovereign default/devaluation than China.
After months of hit money flows in EM stocks sending KOSPI to record highs in the face of rising nuclear tensions with its neighbor, this week saw investors crack as Daiwa analysts warned “Kim looks to have chosen a path of no return.“
As a North Korea war potential approaches, with the regime said to have attack ready nuclear missiles, Daiwa analysts Kevin Lai and Olivia Xai note the awkward position the US military and diplomatic corps finds itself.
“It seems the US has miscalculated the possibility and time needed for North Korea to make a program deliverable,” they wrote, and there is a sense the point of no return is passing.
“The window for the US to ‘denuclearise’ the North has almost shut.”
Escalating tensions over North Korea have also sent the dollar surging against the won to test a critical downtrend line resistance in a triangle formation.
The situation looks tenuous, Daiwa notes:
By making such a promise, Kim looks to have chosen a path of no return. If he delivers the plan, the US will almost certainly respond aggressively with a range of military options — and the situation will escalate to a major military conflict involving several more parties, including South Korea and Japan. There would be little room for either side to step back. If Kim doesn’t deliver, he risks creating a political crisis for himself and permanently weakening his regime. He is now in a position similar to the one Saddam Hussein was in before Desert Storm. His primary goal is regime survival. Giving up nuclear weapons would mean abandoning that goal; bending to US pressure would leave him politically vulnerable at home.
While a nuclear war appears a distinct possibility, stock markets are acting rather benign.
“Korean assets have seen a modest ‘risk off’ over the past two weeks, but this most likely reflects a modest cooling in global growth data,” observed Goldman Sachs analysts Charles Himmelberg, Goohoon Kwon and James Weldon in an August 9 report.
The South Korean KOSPI stock exchange, while trading lower since July 24, remains near all-time highs.
They think too little geopolitical risk has been priced into the market.
“We still suspect that investors are more concerned than markets reveal,” the Goldman report mused.
“Even though tensions continue to mount and North Korea’s nuclear program continues to advance, it appears markets have yet to see enough evidence that this time is different.”
As The Wall Street Journal notes, so far, markets have shown a muted impact.
“The small size of the moves (on a historic basis) is reflective of the extreme difficulty the market faces in pricing in the ramifications of a nuclear confrontation,” said analysts at Rabobank in a note Friday.
In recent years repeated flareups between the U.S. and North Korea have been resolved, or at least not escalated, and market reactions have reversed relatively quickly.
“For decades, complacency has been the ‘right trade,’ when it comes to North Korea,” said global markets analysts at Goldman Sachs in a note this week. “More often than not, market participants have been rewarded for fading negative price moves rather than hedging them.”
“The market’s view is likely too sanguine in short term,” according to analysts at Citi. “This reflects investors’ experience that geopolitical rhetoric can quieten as quickly as it escalates, and a pervasive belief that the true risk of military confrontation is minimal.”
There are different endgames, with the US simply tolerating North Korea possessing nuclear weapons and moving forward a distinct probability path. Regardless of the outcomes, the markets may be mispricing the situation, particularly if it turns negative.
“Financial markets aren’t good at thinking about geopolitical risks,” the Daiwa report noted. “If this crisis escalates further, markets could well find themselves in a state of shock.”post was originally published on this site