While turmoil in the Trump administration pummels financial markets, Citigroup analysts are warning investors also need to prepare for rising North Korean risk.
Though it is tough to price anything other than higher volatility in the short-term, aggression from an insecure North Korean regime and a global response to it could disrupt supply chains, dent global confidence and hurt capital flows, Citigroup analysts led by Johanna Chua said in a note titled, “North Korea risks – this time it is different.”
While the threatening rhetoric and military provocation including nuclear-weapon tests by the regime in Pyongyang have been going on for years, there’s “good reason to believe that risks are ratcheting higher now than in the past,” the analysts said.
Singapore and Vietnam will most likely be affected by any supply disruption and heightened military activity could derail global growth and lead to a oil shock, the analysts said.
They cited the following four reasons:
- The North Korean regime has become more unpredictable under Kim Jong-Un.
- The country’s ballistic-missile program is making technological progress.
- A more unpredictable US foreign policy
- China may still prefer a nuclear-armed North Korea than a failed state.
The analysts said they didn’t see diplomacy soothing the rancour or North Korea agreeing to denuclearise.
They listed five possible outcomes:
- Restraint on all sides with the help of sanctions threats (Citi’s base case scenario).
- North Korea conducts a sixth nuclear test, but over time, caves in to sanctions pressure.
- North Korea conducts a sixth nuclear test and the US pursues carefully targeted “surgical” military strikes (low probability).
- All-out military conflict, impacting Seoul and/or Tokyo (Low pobability).
- A return to diplomacy, with a multilateral framework.
Citi analysts predict Vietnam and Singapore would be the most affected by any supply disruption from Korea, while Thailand, Taiwan, Korea, Malaysia and the Philippines are more exposed to problems in Japan’s supply chain.
A demand shock is unlikely to be contained to North Asia and could spill over globally, impacting more open economies, they said.
Any abrupt withdrawal of liquidity from Japanese banks is likely to be globally significant.
And a major shock event would likely prompt a sharp demand for safe assets bolstering the yen in the short-term though weakening it if the conflict persists.
The Aussie and Kiwi would fall while the Swiss franc and the greenback would likely benefit from safe-haven flows, the analysts said.