A North Korean war appears as a distinct possibility, but the markets appear not to be pricing in this possibility. As NBC news reports Thursday that US intelligence agencies are “unanimous” in their assessment that North Korea has a mini nuclear weapon, a Daiwa Capital Markets report says renegade leader Kim Jong-un has “chosen a path of no return” with “little room for either side to step back.” But are markets pricing in the possibility that the US will be forced to tolerate a nuclear North Korea?
North Korean war

North Korean war: Window for the US to ‘denuclearise’ the North has almost shut.

As a North Korean 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.”

It is unclear if President Trump’s fiery rhetoric was made with the knowledge that the window to stop the regime was closing when he drew a proverbial line in the sand, but the public situation could result in confrontation or one side losing face and backing down.

After US President Donald Trump said continued threats from North Korea would unleash “fire and fury like the world has never seen,” the North Korean regime has only accelerated its rhetoric.

North Korean state media reported that a plan was being put together to fire four missiles at the US Pacific territory of Gaum “within days.” The potential flight path, which would extend nearly 2,000 miles in near 18 minutes and head over Japanese territory, could land on the 210 square mile area where 162,000 people are located, including 7,000 military personal.

The island is a key force in the region and houses bomber brigades assumed to be part of any first strike attack against North Korea.

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. 

North Korean war: Analysts say stock market is not pricing in war risk

While a nuclear war appears a distinct possibility, global 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.”

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.”