You know, we’d be remiss if we didn’t remind you that we’ve been warning about complacency on the North Korea issue for months.
Specifically, we’ve marveled at the persistent inflows into Korean assets amid rising tensions.
Recall that it was less than a month ago when we penned “Offshore Money Is Pouring Into This Country At The Fastest Pace In 5 Years,” a post in which we observed that inflows into Korean equities were proceeding at a break-neck pace:
That of course has helped propel the Kospi to record high after record high despite the increasingly shrill tone emanating from Pyongyang.
As our homegirl Tracy Alloway reminded investors earlier this morning, BofAML’s David Woo has been keen on flagging the risk posed by the “game of chicken” between Trump and Kim. We documented Woo’s thoughts at length in several posts including the one mentioned in the following tweet:
Well, here we are on Wednesday staring down a nuclear confrontation and for their part, Goldman wants you to know that markets still aren’t pricing in armageddon.
Derivative markets in equities do not show much sign of geopolitical tensions. Back in May, we found that for the KOSPI both the 25-delta one-month implied volatility and the 25-delta put-call skew mirrored the vol pattern in European and US equity markets, which suggested that the French elections, not Korean tensions, were driving vol. As Exhibit 1 shows, KOSPI skew increased slightly yesterday after gradual rises in recent weeks (consistent with the delta one move we noted above), but has only now caught up to the levels of skew seen in European and US equity markets.
FX-implied volatility, on the other hand, appeared to hint at some lingering anxiety when we last looked in May. The clearest evidence of geopolitical concern we found was in KRW/USD implied skews, which rose in April amid the arrival of US carriers in the region, and remained near three-year highs.
As Exhibit 2 shows, KRW skew rose on Aug 9 after falling steadily in the intervening months and is now back to where it was in the early spring when US-North Korea tensions began to escalate. The steady decline (until end-July) suggests that the few modest concerns we documented in Korean derivatives markets back in May seem to have moderated even as geopolitical concerns have continued to grow, suggesting that markets were discounting the risks of military action or tougher bilateral sanctions.
We still suspect that investors are more concerned than markets reveal. 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.
Yes, “markets have yet to see enough evidence that this time is different.”
Well, allow us to show “markets” why “this time is different,” with the help of some handy visual aids.