Trump, Russia, Comey, North Korea: A noxious mix for markets

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  • A noxious mix for markets
  • Global stocks down so far
  • New York futures little changed
  • Canadian dollar at 73.3 cents
  • North Korea: ‘This time it’s different’

It’s hard to keep track of the fast-moving events in the Washington circus, what with all the elephants, clowns and lions.

But one thing is clear: Add North Korea to the turmoil, and it’s a fairly noxious mix for investors.

As The Globe and Mail’s Tim Shufelt reports, stocks plunged Wednesday as the word “impeachment” was heard among politicians and market analysts, raising questions about whether investors will ever see the fiscal and economic reforms promised by President Donald Trump’s young administration.

“At this point, one could hardly imagine a worse scenario than an eventual Trump impeachment for the markets,” said London Capital Group senior market analyst Ipek Ozkardeskaya.

Even though it’s obviously too soon to predict what could unfold, “if Donald Trump is impeached, his massive infrastructure spending plans and the colossal tax reforms would never see the daylight,” she added.

“Hence, the past six months’ reflation rally would face severe reversal risks. If the markets were to retrace the Trump-reflation gains, this would trigger a decent ‘deflation’ squeeze.”

Stocks are down again today across the board, though we’ll see how North America fares.

Tokyo’s Nikkei lost 1.3 per cent, Hong Kong’s Hang Seng 0.6 per cent, and the Shanghai composite 0.5 per cent.

In Europe, London’s FTSE 100, Germany’s DAX and the Paris CAC 40 were down by between 0.4 and 0.8 per cent by about 4:30 a.m. ET.

New York futures were little changed, and the Canadian dollar was at about 73.3 cents (U.S.).

Here’s what other observers are saying:

“We believe that too much of the discussion around the latest disputed events is caught in a political maelstrom and partisan views get meshed into investment recommendations. Thus, we would be careful not to use emotional responses and personal likes and dislikes to arrive at conclusions … We see the market’s pullback as rational but we would not get overly anxious about it in view of a 2,560 mid-year 2018 S&P 500 target.” Tobias Levkovich, Lorraine Schmitt and Jennifer Stahmer, Citigroup Global Markets

“The big question now is whether this turns out to be the start along a road to an impeachment process or whether this is another bump in the road. Depending on how events play out over the next few days, that planned rate rise for the U.S. Federal Reserve, which is due next month, might well have to be put firmly on the back burner.” Michael Hewson, CMC Markets

“What we do know is this bout of risk aversion is certainly about a giant push back on the future of tax reform and Trump’s ability to deliver (anything) has been dealt a massive blow given the level and magnitude of controversies in play … The moves in financial markets have been brutal, not because of the absolute size of the move, but specifically because of the size of the move after a prolonged period of such subdued implied volatility.” Chris Weston, IG

Investors may be fretting over the chaos in Washington, and with good reason.

But they should keep a wary eye on Pyongyang at the same time, also with good reason.

As Citigroup Global Markets put it in a report on North Korea and the potential for market turmoil: “This time it’s different.”

“Financial markets need to care: It is tough to price anything other than higher volatility in the short term, but there are clear risks to supply chains and to global confidence, as well as implications for capital flows that could upset market equilibria,” said the report led by Joanna Chua, Citi’s head of Asia-Pacific economic analysis, with her colleagues at the big U.S. bank.

The Citi team gave four reasons for why the tensions surrounding North Korea and Kim Jong-un are a bigger threat now than in past episodes, and laid out five scenarios, the base case being that everyone shows “restraint.”

There are scarier scenarios, as well, given that Kim Jong-un is “likely more insecure and, thus, more unpredictable” than his father.

Why it’s different this time

The Citi report is lengthy, and the analysis deep, so I can’t do it justice here. But that unpredictability tops the list of the four reasons why. The others:

Scariest of all is the reason that goes far beyond the markets: “Technological breakthroughs in North Korea’s ballistic missile program which may be approaching ICBM capabilities.”

But there’s also the “more unpredictable foreign policy” of the Trump administration, which means you have unpredictability meeting unpredictability.

And finally, according to Citi, China “may be willing to live with a nuclear North Korea rather than risk having a failed state at its doorstep.”

The scenarios

“We have little faith that diplomacy can succeed in shifting the negotiating positions of different parties,” the Citi analysts said, warning that ongoing tensions are probable.

“Tighter sanctions may need be pursued, and the regime may test the resolve of the U.S. and China, instead.”

The first scenario, the base case, as noted, would see everyone involved showing restraint, but “with the help of sanctions threats.”

The second scenario, which Citi described as a reasonable probability, envisions North Korea launching a sixth nuclear test but that it later “caves in to sanctions pressures.” Actual sanctions don’t work that often, the bank added.

Scenario 3 – low probability – sees the Trump administration in “carefully targeted military strikes” as a response to a sixth test.

Number 4 – thankfully, very low probability – is for “all-out military conflict, impacting Seoul and/or Tokyo.”

The final scenario would see “a return to diplomacy with a multilateral framework.”

Potential market fallout

“A negative demand shock is unlikely to be contained to North Asia and could spill over globally,” said Ms. Chua and her colleagues.

“A global growth or oil shock is possible on any significant escalation.”

The first scenario sees little economic impact as “fundamentals continue to remain stable.” As does the fifth scenario.

Number 2 could see a “short-term rise in risk aversion,” though investors could grow more troubled than in the past should Washington raise the temperature through rhetoric or if sanctions are too harsh.

As Scenario 3 sees an escalation, so too would the fallout be greater, with “a significant blow to confidence and economic performance, especially in South Korea and Japan who bear the brunt of risks from possible North Korean retaliatory strikes.”

All bets are off under the fourth scenario.

“Any attack on populous civilian centres in either South Korea or Japan would have a significant economic impact, with a recession the likely result for both, and dramatic ripple effects would be seen globally,” Citi said.

“Japan and South Korea account for 8.4 per cent of global GDP and 6.9 per cent of global trade, and as any significant conflict will involve the world’s two largest economies, the U.S. and China, given their respective security guarantees with South and North Korea, respectively, a serious geopolitical event in the Korean peninsula will likely be a source of systemic risk globally.”