US - North Korea: risk aversion likely to be temporary, although bumpy - Danske Bank

Analysts from Danske Bank explained the impacts of the escalation in the tensions between North Korea and the US. They see the current risk aversion likely to be temporary.

Key Quotes: 

“The most likely scenario is that the current escalation of events does not lead to a military confrontation as both parties will have too much to lose from such an outcome. However, it is also difficult to foresee a sudden improvement in US-North Korean relations and recent events may increase long-term frictions in US-China relations.”

“Military confrontation between the US and North Korea is a low-probability but highimpact event for markets. That naturally makes it difficult for markets to price it. In recent years, geopolitical tensions have had a brief, albeit sharp, impact on markets as central banks have come to the rescue” 

“In our base case, in which the North Korean situation does not escalate into a military confrontation, we would expect the current risk aversion to be temporary although it is likely to be bumpy and very much headlinedriven.”

“In the risk scenario, where the current tensions escalate sharply, we would expect an acceleration of this week’s price action, i.e. a sharp rise in risk premiums across asset classes, substantial falls in US and German government bonds yields, significant JPY and CHF strength and a massive sell-off in equities, particularly in Europe which is more linked into the global cycle.”

“Looking beyond North Korea and assuming that the situation does not escalate, the world economy is looking strong. Our quantitative business cycle model, MacroScope, signals that the global recovery will remain intact in H2 and that the US economy is gaining speed. This is positive for equities, especially for the US. The positive cyclical outlook for the US also supports our view that US yields will head higher in coming months.”