North Korea this morning fired what was likely an intermediate-range ballistic missile over Japan into the Pacific. After a short period of calm the North Korean crisis is again escalating.
How serious is this? The missile test is clearly a strengthening show of force from North Korea to show they are not bending to US demands. That the missile is flying over Japanese territory is a clear provocation, although not the first time it has happened. As late as 2016 North Korea fired a rocket over Okinawa. At the same time, North Korea did not go through with its’ plans to send the missiles close to the waters of Guam as they had indicated on 9 August. Kim Jong Un had said he was reconsidering this and the missiles into the Pacific can to some extend be seen as a moderation compared to the initial plans. Japanese Foreign Minister Taro Kono said the launch to the east rather than to the south towards Guam was a sign Pyongyang ‘flinched’ in the face of US warnings.
North Korea had warned that the annual military exercises of US and South Korea taking place during these weeks would trigger a reaction. The so-called Ulchi-Freedom Guardian military exercises started earlier this month. It is not unusual that these exercises escalate tensions. Last year North Korea launched a missile from a submarine around the time of the exercises and put its military on high alert. China had asked US and South Korea to suspend the drills this year in order to ease the conflict and pave the way for diplomatic talks.
What’s next? Following today’s launch Japan has asked the United Nations Security Council to hold an emergency meeting. More sanctions may be imposed but we still see war as a very low probability as the risks involved on both sides are simply too big. Ultimately we believe that we will have talks between the involved parties. But before that both sides will need to illustrate a big show of force to strengthen the positon at the negotiating table. What the response might be from the US side this time is not clear. But a military strike does not seem likely.
A diplomatic solution is difficult as it will require on the one hand that North Korean demands for an end to the annual military exercises are difficult to obtain because US and South Korea sees a big threat from North Korea. Similarly the demand from the US for North Korea backing down from their nuclear ambition is also difficult as long as they see the US as a major threat. Eventually there is only a diplomatic solution to this as a military conflict would entail severe losses on both sides. But the road there will not be easy and we are likely to see continued waves of escalations before the parties are ultimately pushed to the negotiating table.
Market outlook: The markets reacted again with the usual safe haven flows sending equities and bond yields lower. Asian stocks took a hit again as after the recent escalation. But things will likely calm down again soon and markets recover. Overall, though, the crisis is keeping risk appetite dented as long as we see these continued waves of escalation. In combination with the looming US debt limit deadline coming closer risk markets will find it hard to gain real momentum despite overall positive growth numbers at the moment.
Below are an outline of recent events:
29 August:
North Korea fires missile over Japan into the Pacific
16 August:
Trump praises Kim Jong Un for ‘wise’ decision on Guam
15 August:
Kim Jong Un said he would watch the actions of the US for a while longer before making a decision to strike the area around Guam with missiles.
14 August:
South Korean President Moon Jae-In said Seoul would avoid a second Korean War at all costs and that “Military action on the Korean Peninsula can only be decided by the Republic of Korea and no one may decide to take military action without the consent of the Republic of Korea”. US Defence secretary James Mattis said if North Korean missiles were considered to threaten Guam “then it’s game on”
11 August:
Trump tweets that “Military solutions are now fully in place, locked and loaded, should North Korea act unwisely. Hopefully Kim Jong Un will find another path!”
9 August:
North Korea army says it plans to launch missiles to hit close to the American island Guam in mid-August. Rex Tillerson says he sees no “imminent threat” of North Korea attack. “Americans should sleep well at night”.
8 August:
US intelligence officials concludes that North Korea has successfully produced a miniaturized nuclear warhead that can fit inside its missiles. If true it would mean that North Korea could already have reached their aim of having capability of reaching the US with a nuclear warhead as Intercontinental Ballistic Missiles (ICBM) tested twice in July would have been able to reach US if fired at a lower angle. Trump says that US would respond with “fire and fury like the world has never seen” if North Korea persisted threatening US. The statement was apparently improvised and said to surprise his aides.
5 August:
UN take unanimous decision to launch new sanctions on North Korea. Among other things it introduces a full ban on coal, iron and iron ore to banned commodities for import. Estimates say it may cost up to USD1bn per year for North Korea.
1 August:
US Secretary of State Rex Tillerson says US is willing to talk to North Korea saying North Korea is not the enemy of the US and that US does not seek regime change. The precondition for talks, though, is that North Korea backs down from their nuclear pursuit. North Korea denies to back down and demands that US and South Korea stops annual military exercises (expected to kick off later this month). The US reject this request. Tillerson has generally been the calm and responsible voice on the North Korean issue.
