Originally published by The Commonwealth Bank of Australia
The crazy world of Donald Trump escalated overnight. The commander and chief breathed fire upon the wires. And we heard North Korea was nuclear capable. Trump said North Korea "will be met with fire and fury and frankly power. The likes of which the world has never seen before". I can’t get images from the Pitt‑flick “Fury” out of my head.
The RBA’s Kent delivered a timely summary of fixed income markets in Australia. The speech is a great introduction, with important post‑crisis developments covered. The Q&A also offered interesting insights on the currency and outlook. The RBA is simply waiting and watching with double‑sided risks. And the cash rate of 1.5% will be held into 2019, in our view.
The Face of War and a first mover disadvantage for Kim
The acceleration in the perceived nuclear threat from North Korea points to a building justification for US military action. North Korea has now threatened a pre‑emptive strike on the US military base in Guam. Actions speak louder than words. But words are getting heated, fuelled with fire and fury. North Korea is not much more than a car‑park in‑waiting, in the eyes of Americans. North Korea would be remiss to call their own bluff and start throwing down. Such a silly manoeuvre would force US action and sideline their ally, China. And it’s all about China.
For what it is worth, Australian PM Turnbull chipped in and made the key point: “The North Korean regime's conduct is as illegal as it is reckless. It threatens the peace and stability of the region and the world, and they have to come to their senses… Every economic pressure that can be imposed must be imposed and Australia is playing its part. While every nation should be united in bringing this rogue regime to its senses, we note especially the importance of China's role as North Korea's major economic partner, China has unique leverage. And we welcome, in particular, China's support for these strong and much‑more harsh sanctions imposed by the Security Council. The regime must come to its senses and stop its illegal provocations.”
The real conflict is between the US and China. It’s like meeting that schoolyard bully behind the bike shed. North Korea is just the bike shed. You either turn up and flatten him, or suffer the silly threats in the classroom thereafter. Recent escalation in classroom threats, made both ways, mixed with more details of nuclear capability, suggest some sort of meeting is inevitable. Let’s hope it stays behind the bike shed. Whether the bike shed remains standing after the altercation, or is flattened into a carpark, depends on how China deals with the US.
For markets, you want more fixed income in your portfolio in times of heightened risks of war. You also want US dollars, the likely victor, and they’ve been cheapening of late. You don’t want Antipodean currencies, unfortunately. Antipodean currencies have been strengthening of late, thanks to commodity prices that would get burnt in a war‑fuelled frenzy in markets. You do want that shiny stuff we’ve loved for millennia. Gold and silver stand the test of time, the test of inflation, and the test of regime change. Maybe a few extra bars under the bed. It never hurts, ask Buffet.
In the face of war you buy US dollars, US bonds, gold (silver), francs, yen and a Pound of flesh (stering). Asian currencies along with Antipodean currencies would be hurt the most in conflict, as growth expectations shatter. Antipodean fixed income markets would rally hard, a comfort to local investors, more so than international investors facing currency depreciation.