David Lafferty
“The most likely scenario for U.S./North Korea relations remains an uneasy status quo. First, outright military conflict seems unlikely. North Korea will continue to irritate the US and Asian allies with missile tests, but Pyongyang surely recognizes that any strike would bring an overwhelming response.
“Likewise, the US has few good options for effectively reining in Kim. Military action risks putting Seoul and Tokyo in Pyongyang’s sights – along with forcing China’s hand – a price too high to pay. Second, diplomacy and further sanctions can only be effective if China exerts more influence. This too however would yield only marginal results as China remains reluctant to fully embrace sanctions against its neighbor and because Kim is unlikely to fully comply with Beijing’s demands. President Trump’s recent threats to withdraw from the nuclear deal with Iran will only boost Pyongyang’s resolve to maintain and grow their nuclear capabilities.
“Caught between the mutual downside of war and the limited effectiveness of sanctions, North Korea will continue to play out in the background of markets. While August’s tensions created a mini-spike in VIX to 16 – still a fairly low reading of fear – more recent launches in September have seen no significant flight-to-quality reaction. Markets appear to be developing Kim fatigue.
“Moreover, Trump’s recent deal with democrats to delay the debt-ceiling deadline and the revival of his tax reform plans have bolstered stocks and put North Korea on the back-burner. As long as markets continue to believe that armed conflict is unlikely, North Korean news will continue to little impact on markets.”
By David Lafferty, Senior Vice President and Chief Market Strategist