US President Donald Trump and North Korean leader Kim Jong-un will both have a strong incentive to declare victory after this Tuesday's historic peace talks; markets are likely to be more skeptical. The twists and turns of the long-term standoff between the two countries have provoked little market movement. For example, North Korean missile tests last year corresponded with an average single-day decline of just 0.1% in South Korean equities. And when Trump called off talks last month, an initial risk-off turn in markets swiftly faded.
But decisive progress in the dispute could reassure investors, removing one political dispute that has distracted attention from strong corporate earnings and economic growth. We will be on the alert for several developments:
- Progress on denuclearization: The central tension of the talks is that the US wants North Korea to denuclearize, while the North Korean regime appears to regard possessing a nuclear arsenal as vital to its survival. North Korea could be skeptical of US guarantees after the administration pulled out of the Iran nuclear deal. Any progress here, especially if backed up by international inspections, would likely constitute significant progress.
- Agreements on missile capabilities: The US could seek an agreement to scrap North Korea’s intercontinental ballistic missile program, which would keep the US out of the range of its weapons. Such a deal could be seen as the US leaving its allies in the lurch, since South Korea and Japan would remain in range.
- Soft progress: Even modest concessions from North Korea could lead to a relaxation of US economic sanctions or a scaling up of diplomatic ties. This could eventually lead to progress on the more crucial issues above.
- A grand US-China bargain: The most market-moving outcome of all would be a US-China bargain, linking both the trade dispute and a deal to end the North Korea conflict. This would be a significant diplomatic coup and would likely boost risk assets.
So, we believe that the most realistic outcomes to the talks are unlikely to affect markets greatly. Although an accord to formally end the Korean War may be on the agenda, the meeting is more likely the start of a gradual process than a grand summit that will produce decisive results. That said, an unexpected breakthrough would remove a lingering political worry for investors and could encourage them to focus again on strong earnings and economic fundamentals.
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