Tentative calm as North Korea rhetoric dies down

The markets have opened with an eerie note of calm at the start of a fresh week, as the US-North Korea tensions stalled over the weekend as President Trump dealt with more pressing matters of domestic terrorism. The Swiss franc and gold are lower in early trading, while Asian currencies are managing to show some signs of recovery after last week’s rout. The Hong Kong dollar is higher along with the South Korean won. Futures markets are also predicting a positive open from the US later today, and if this materialises it should help to lower Wall Street’s fear gauge, the Vix index.

North Korea threat on the backburner for this week  

The fact that we didn’t see an escalation in the rhetoric from either side over the weekend could be enough to trigger a recovery after last week’s risk selloff, and keep the markets focused on the economic fundamentals. This is particularly relevant for the pound, which is also back above $1.30 at the start of the week, as we lead up to key CPI and labour market data releases on Tuesday and Wednesday. However, there is still the potential for another sell off in the short term. From August 21^st the US and South Korea are conducting joint military exercises in the region, which are likely to entice the wrath of Pyongyang. If it compels Kim Jong-un to threaten a nuclear strike on Guam then expect another spike in volatility and risky assets to sell off. A second bout of risk aversion could be worse than the first as the second half of August tends to see even lower levels of volume and trading activity as the UK and US gear up for public holidays. Thus, gold and Swissie selling could be fairly muted even if the US and North Korea manage to keep Schtum for a couple of days.  

Watch tech for market direction

Aside from North Korea there are some genuine concerns that valuations are now getting strained. Technology shares led the market rally higher this year and they are likely to lead it lower when the time comes for the market to correct. Thus, price action in the FANGS will be worth watching closely in the next day or two. Apple fell sharply on Wednesday and Thursday last week and was down 4%, it managed to recoup nearly half of that loss on Friday. However, the market will likely only be comfortable with the tech titans once Apple gets above last week’s high at $161.83, Friday’s closing price was $157.48. If we get a failure at this level then it would give a big clue about market sentiment, namely that it is fragile and any further escalation in geopolitical fears, and/ or signs of stress in the credit markets could be enough to trigger a deeper market sell off.

Do geopolitical fears even matter any more?

Of course, it is worth remembering that geopolitical fears have barely left any long-lasting marks on financial markets for coming on 30 years. Thus, threats from North Korea are unlikely to be any different this time. Unfortunately, the markets may only react if the nuclear trigger is actually pulled, which cannot be ruled out at this stage.

Tesla debt sale also a source of market calm

If this spat is resolved, and the market appears to be assuming that it will be, then one further risk has also been eradicated: Tesla’s debt sale. It managed to sell more debt than planned on Friday at a yield of 5.3%, which is just over double that which the US government can borrow at. This, for a company that is basically rated junk, and has a major production bottleneck, is no mean feat. While it doesn’t take a genius to figure out that electric cars are the future, to be able to sell Tesla debt last week when volatility had spiked to its highest level for 9 months and Tesla’s stock actually sold off 3%, suggests that the hunt for yield is likely to steady the ship for risky assets, no matter what President Trump and Kim Jong-Un throw at it.

Is Jackson Hole the biggest risk for markets?

This makes the Jackson Hole central bankers’ conference on 24-26^th August the most important event for investors in the short term, and any hawkish rhetoric from the major players at the Fed or the ECB could be enough to trigger a sell off in risky assets. We will look at this in more detail closer to the time, however, our base case is that we get a less hawkish Janet Yellen and a more hawkish Mario Draghi, which could be enough to trigger the next stage of the EUR/USD rally after it stalled around the 1.1910 high at the start of August.

Ahead on Monday, we will be watching how risky assets perform and if there is follow through on this tentative recovery. We will also be expecting the Vix to retreat. Eurozone industrial production and Japanese GDP are the economic highlights.