How the Markets could React to a North Korea Strike

       (AP Photo/Jon Chol Jin)

       (AP Photo/Jon Chol Jin)

It’s difficult to interpret a rational response to an untested modern day warfare strategy using nuclear weapons. Nevertheless, below are a number of possible market scenarios under ‘flash’ and ‘short-term’ constraints.

A nuclear flash point is difficult to factor as it’s considered a non-traditional build up to conflict.

It’s assumed that the US would be required to destroy North Korea’s ability to retaliate in one massive short onslaught, not just its ballistic missile capability. Any strike of this scale would require a massive deployment of battleships and aviation assets to the region.

There are two main reasons for that:

1.     Seoul, South Korea lies less than -100km from the border. It is within artillery strike.

2.     Japan is also within range of missiles and could expect a heavy bombardment.

In a war scenario we could expect the following under flash conditions:

·       USD/JPY could rally immediately above ¥130.00 (possibly ¥140+) and the Nikkei could drop by as much as ~20%. By day’s end, JPY may “not” be a safe haven. However, negating some of the ‘big’ dollar moves will be the fact that Japan is a net overseas investor, both on the retail and institutional levels. Thus, investors who have their assets in ‘non-yen’ is at risk because they are exposed to FX volatility – expect many domestic investors to want to reduce their risk by unwinding some of their overseas investments.

·       USD/Asia – all Asian currencies could depreciate aggressively ~10%+

·       ASIAN stock markets could collapse significantly and probably more in China and Hong Kong.

·       KRW will most likely be untradeable due to liquidity constraints.

·       With trade routes, both east and west, expected to be severely disrupted, this could be particularly bad for Australia. Expect the ASX to come under immediate pressure as a high beta to China and its main export market. Expect the AUD to drop by at least ~10%.

·       USD is expected to appreciate by at least ~5 to 10% against G10 pairs for starters.

·       Global stock markets ex-Asia and APAC could fall significantly, but not at the same pace as its Asian counterparts.

·       Oil will be expected to rally aggressively, up to $70-90+ a barrel (first and second strong resistance points) and then some.

·       CHF could appreciate by ~10% crushing the SNB along the way. It’s already posted its biggest daily rise in 2 and a half years this week on ‘carry’ trade unwinds.

·       Gold will move higher by a minimum of ~20% to towards the key psychological $1500 level and expected to go much higher. Similar moves will be seen in Silver and Platinum.

·       Base metals could collapse as demand from China plummets, or because it is unsafe to transport raw materials.

·       Food prices will suffer a knee jerk reaction higher as Asia scrambles for supplies to stockpile but probably finds that no one will be willing to ship them.

·       Remember: Weekend moves are more prone to significant price gaps due to liquidity constraints.

Under Short-Term conditions:

·       G7 Central Banks will be expected to produce massive cuts in interest rates to head of a liquidity crisis.

·       U.S Treasury’s, Bunds, Gilts yields will collapse – Bunds going strongly negative and U.S 10-year yields to plummet towards +1 – 1.5%.

·       On collateral damage to either South Korea or Japan could see a reversal of some of the USD bets into EUR as a safe haven.