US intelligence concluded that North Korea has recently developed
the capability to produce a nuclear warhead that would fit on to the
intercontinental ballistic missile that it has been developing. This coupled with claims that North Korea was moving to make active
defensive weapon systems, spurred an escalation of rhetoric between the US and
North Korea. President Trump threatened North Korea with a " fire
and fury" as the "world has
never seen." While North Korea reportedly responded by revealing that it was considering a preemptive
strike against US forces in Guam.
Washington contacts suggest
that North Korea is still missing two key pieces of technology. One has to do with the integrity of
the nose one that needs to withstand intense force and heat as it re-enters the
atmosphere. The other is a guidance system. The latter seems to be
of lesser importance.
North Korea would have a
counter-value (urban centers) targeting strategy rather than counter-force
(military targets, like missile silos). Counter-value strategies for obvious reasons do not
have to be as accurate as counter-force strategies. In any event, North
Korea apparently is progressing faster than previously anticipated,
according to the latest thinking, and could be ready in a year's time.
The US has threatened to use
force to deter North Korea, but it prefers to use multinational efforts and
the rhetoric of unilateralism, the Trump Administration is attempting to find
an alternative to a US-North Korea confrontation. China has taken modest
steps, but it has no desire for unrest on its borders, and it fears that a
united peninsula would be dominated by
South Korean interests, which means the US.
Japan, with whom the US has
a security treaty, has been threatened by North Korean missiles for many
Minister Abe has been pushing for a stronger Japanese
military, and through a recent reinterpretation,
its defense forces can be used to defend allies. A united Korea would be
a significant economic rival. For its part, South Korea's new government
appears willing to accept the fait accompli and continue to seek a negotiated
There have been many op-ed
pieces comparing the current situation with the Cuban Missile Crisis. This
tends to be cited by those who sense the
Rubicon is imminent and want decisive action now. On the other hand, the
experience with Iran may be more apropos. It is a marathon, not a sprint. There is the creation of an incentive
structure that was ultimately persuasive for Iran.
There is also a good reason why time is on America's side. Its missile defense system
continues to become more sophisticated. Remember the US spends roughly as
much on defense as the rest of the world combined. South Korea has begun
installing a US missile defense system, and it has antagonized China, which
sees it as a forward projection of US power to its border.
The markets have barely
responded to the escalation of rhetoric. The US dollar enjoyed a firm tone, but we would
suggest that the move began last week and
that the in our assessment both technical and
fundamental considerations favored a stronger dollar before these latest
developments. Gold enjoyed a large outside up day on Tuesday by trading
on both sides of Monday's range and closing above Monday's high. This is a constructive technical sign, but in
the spot market, gold stopped at $1265.50, the 61.85 retracement of its losses since the start of the month.
US T-bill yields were little changed (one-month bill yield move on
Tuesday was about a quarter of a basis point). The US 10-year yield is
also essentially unchanged since the end
of last week.
The Dow Jones Industrials
snapped a 10-day rally with a minor loss (-0.15%), while the S&P loss of
0.25% looked more ominous, with a potential key reversal. The S&P 500 made a new record high
(~2491) before selling off through Monday's low (~2476) and closing below
there. The S&P 500 has been up every month this year but March.
Worries about Korea did not seem paramount to the accounts of
Tuesday's price action. Given the failure of the US market to hold on to
early gains may also weigh on Asian shares on Wednesday.
The yen is interesting. It is the only major currency
to have gained against the US dollar over the past five sessions. These
gains have come over the last several hours. We argue that the safe haven appearance of the yen is largely a
function of the behavior of Japanese investors and short-covering rather than
the yen and Japanese markets that investors are putting their savings for
security. We suspect that the unwinding of long euro and short yen
positions weighed on the dollar against the yen. A break of JPY109.85 could see the dollar fall toward
JPY109 rather quickly. This, in turn,
could lift the yen on the crosses, and push
the likes of the euro, sterling, and Australian dollar lower.