Goldman Is Amazed By The Market's Non-Reaction To The Korean Crisis

One of the recurring themes of broad market complacency has been traders' unwillingness to price in, or even react, to surging geopolitical risk. This morning, Goldman picks up on this conundrum, with a note by Charles Himmelberg in which Goldman's chief credit strategist expresses his dismay at market reactions to surging political risks and threats, and focusing on the latest events in North Korea, writes that "our sense is that investors have grown comfortable with the view that geopolitical tensions invariably result in diplomatic talks, in which case the right trade is to buy any dips. The result is a market psychology that is relatively resistant to the pricing of geopolitical risk."

Taking a step back, this is how he summarizes the latest market events:

North Korea risk continues to rise. A series of ICBM launches in recent weeks prompted the UN to pass new sanctions last weekend, prompting sharply worded statements between North Korea and the US over the past few days. Yesterday Japan elevated its North Korea threat level and news outlets reported that the US Defense Intelligence Agency believes North Korea has already developed missile-ready nuclear warheads.


Markets have been pricing a diplomatic outcome, although the escalating war of words over the past 24 hours between the US and North Korea has caused a modest repricing of Korean risk assets and global safe havens. That said, the KOSPI remains near all-time highs and the pricing of tail risk in Korean derivative markets still shows little sign of concern.

To be sure, this is not the first time Goldman has discussed just how inert to political shocks the market has become. Back in May, the firm argued that "geopolitical tensions on the Korean Peninsula were “rising, not pricing”. Since then, the risks have continued to mount, while markets appear to have taken the tensions in their stride. According to a new Pentagon assessment, North Korea will be able to launch a reliable, nuclear-equipped intercontinental ballistic missile as early as next year. In response to the new UN sanctions this weekend, North Korea’s state-run news agency accused the US of "trying to drive the situation of the Korean Peninsula to the brink of nuclear war" and vowed to “make the US pay dearly for all the heinous crimes it commits against the state and people of this country.”

In the biggest event of an otherwise quiet day, President Trump continued the war of words yesterday, stating that aggression would be met with “fire and fury like the world has never seen.” Also yesterday, Japan upgraded its official assessment of the threat from North Korea, cautioning that the threat had entered a “new stage” and that North Korea may have already acquired the ability to weaponize nuclear warheads.

And, as Himmelberg adds, while overnight markets began to take notice after North Korea made comments regarding plans to attack Guam, the KOSPI stock index still remains is just 4% from the all-time high it reached in May.

Below is Goldman's take on why the market is so convinced that no matter what, the North Korean situation will be resolved favorably, and why there is no need to panic:

For decades, complacency has been the "right trade” when it comes to North Korea. More often than not, market participants have been rewarded for fading negative price moves rather than hedging them. Our sense is that investors have grown comfortable with the view that geopolitical tensions invariably result in diplomatic talks, in which case the right trade is to buy any dips. The result is a market psychology that is relatively resistant to the pricing of geopolitical risk.


Korean assets have seen a modest 'risk off' over the past two weeks, but this most likely reflects a modest cooling in global growth data. Since July 24 and prior to the last 24 hours, the trade-weighted Won had depreciated 1% while the KOSPI had declined 2.5%. These moves are consistent with the recent weakening of our Global Current Activity Indicator (CAI), which moderated to 4.3% in July from 4.9% in June. The export-intensive Korean economy tends to track the global demand environment closely. In addition, Korean markets might have been affected by recent policy initiatives of the new pro-labor government, including tax hikes and a historical minimum wage hike. But since the geopolitical risks on the Korean peninsula are more tail events than modal events, we prefer to look at derivative markets for evidence of market pricing.


Derivative markets in equities do not show much sign of geopolitical tensions. In our May report, we found that for the KOSPI both the 25-delta one-month implied volatility and the 25-delta put-call skew mirrored the vol pattern in European and US equity markets, which suggested that the French elections, not Korean tensions, were driving vol. As Exhibit 1 shows, KOSPI skew increased slightly yesterday after gradual rises in recent weeks (consistent with the delta one move we noted above), but has only now caught up to the levels of skew seen in European and US equity markets.


Exhibit 1: KOSPI vol has risen over the past 24 hours...
KOSPI, Euro Stoxx 50, and S&P 500 skew (one-month 25-delta puts minus one-month 25-delta calls). Data as of 3PM HKT, Aug 9.


FX-implied volatility, on the other hand, appeared to hint at some lingering anxiety when we last looked in May. The clearest evidence of geopolitical concern we found was in KRW/USD implied skews, which rose in April amid the arrival of US carriers in the region, and remained near three-year highs. As Exhibit 2 shows, KRW skew rose on Aug 9 after falling steadily in the intervening months and is now back to where it was in the early spring when US-North Korea tensions began to escalate. The steady decline (until end-July) suggests that the few modest concerns we documented in Korean derivatives markets back in May seem to have moderated even as geopolitical concerns have continued to grow, suggesting that markets were discounting the risks of military action or tougher bilateral sanctions.


Exhibit 2: ... and so has KRW skew
KRW/USD, USD/EUR, and JPY/USD skew (one-month 25-delta calls minus one-month 25-delta puts). Data as of 3PM HKT, Aug 9.

Goldman's conclusion:

We still suspect that investors are more concerned than markets reveal. Even though tensions continue to mount and North Korea’s nuclear program continues to advance, it appears markets have yet to see enough evidence that this time is different.

A few more tweets and quotes from Trump, however, may quickly change all that.


AR15AU Wed, 08/09/2017 - 08:36 Permalink

so maybe Trump is tweeting armageddon to try and ruin the central bank induced bull market and goldman is quickly scrambling to keep the narrative alive another day?

LawsofPhysics Wed, 08/09/2017 - 08:38 Permalink

Another primary dealer (The Fed) that contributes to the destruction of true price discovery......please, these criminal fucks know that there is no "market"."Full Faith and Credit"Tick tock motherfuckers

NEOSERF Wed, 08/09/2017 - 08:41 Permalink

Algos believe that nuclear war which will eliminate pesky humans and their headlines, tweets and otherwise useless hourly information that complicates their ability to obfuscate the PLAN which is to push the market to 30K before selling off to 6K to then repeat the process is a GOOD thing.

Latitude25 (not verified) Wed, 08/09/2017 - 08:44 Permalink

LOL.  So GS doesn't know the markets are rigged when they themselves are doing it?

Racer Wed, 08/09/2017 - 08:51 Permalink

"Markets" or rather the algos buy and sell to each other at every increasing prices on any hint of war and dead human bodies

shizzledizzle Wed, 08/09/2017 - 08:53 Permalink

I didn't think they let low level Goldmanites talk to the press. Anyone in the know at Goldman knows EXACTLY why the markets don't react. I think I'm gonna go post about the fed on yahoo just so I can get a "The FED doesn't buy stocks, never has" response. At this point I am just intrigued to see what it will take for these idiots to consider it a possibility. 

PitBullsRule Wed, 08/09/2017 - 09:00 Permalink

Wrong Goldman, the market knows Trump is full of shit.  He says all kinds of crazy bullshit, and never follows through.  Same with Kim Jung Un.  Everybody knows these two guys are history's biggest bull-shitters.  Nobody believes a word they say.  The market will plummet like a stone if either one of them does launch a real warhead, but until they do, its just noise.

swmnguy PitBullsRule Wed, 08/09/2017 - 09:32 Permalink

I'm sure you'll collect plenty of red-arrows for blasphemy, and maybe even lese-majeste, but I think you're correct.Phrasing it in the ZH-PC way, the market knows NK's track record.  They only act up when they want and need something.  For all the decades of "They're Crazy!  They want to kill us all!" breathless MSM hype, the record of NK's actual real actions is very pragmatic and not crazy at all.  Ruthless, sure.  Evil; you  could make that case.  But Crazy?  No.  President Trump is not one to leave any possible offence untaken, and especially not to do so in silence.So the stage is set for some sort of walk-down, with a deal brokered in Beijing.  The Chinese know what Kim wants, and all that remains is to map out the process by which Kim gets enough of what he needs and both he and the US get to proclaim victory for domestic consumption.  China's been figuring out situations like this for 5000 years.  They've gotten pretty good at it.The market knows this and is trading accordingly.

In reply to by PitBullsRule

Justin Case PitBullsRule Wed, 08/09/2017 - 10:08 Permalink

The differance is what Kim Jung Un says gets done. Trump is told by TPTB what he is to do. If not, the courts and congress stop him and the media attack him. He has to follow the ajenda he was given. He is just the CEO of USA Inc. and congress are the board of directors. NK is still a country not a corporation, and Kim Jung is da BOSS MAN.Goldman was expecting a winfall in their investments using propaganda and fear mongering. The minions have alternative media that isn't part of the corporatocracy and printing the truth will not result a loss of membership in the elite club. 

In reply to by PitBullsRule

hongdo Wed, 08/09/2017 - 09:08 Permalink

The American elites have lived outside of the real world for so long they do not believe it exists.  And some even think the real world is an alien computer simulation. In this elite world there is no cause and effect or consequences for actions.  Just like in insurance, everything - injury, damage, even life - has been assigned a dollar value like in a video game and can be corrected by application of the right amount of dollars. In the stock market, recent history backs them up.  World events have not had any impact on the market.  The CBs have had the only impact on the market.  So what should they deduce? It's the scientific method looking at the evidence.Real world:  Escalating normalcy to a frog boiling temperature. 

Blurb Wed, 08/09/2017 - 10:21 Permalink

When can the world learn to just ignore NK? Every looney pronouncement from them should be answered with a 'Yeah yeah yeah' and nothing more.Let them goose-step all they like and eat sand for all I care. But stop letting such a bunch of freaks dominate the news.   

Grandad Grumps Wed, 08/09/2017 - 10:42 Permalink

Why should anyone take the government, the lying mainstream media or Goldman seriously?

There is a credibility gap when everything is aimed AGAINST the people.

... Oh, and if Goldman wants a reaction, they should create one, since they control both price and volume.

Arrow4Truth Wed, 08/09/2017 - 10:55 Permalink

"Amazed by the market's non-reaction to the Korean crisis?" It's not a goddamned crisis you "the sky is falling" pig-fuckers. Just another distraction so they can get their hands deeper into your pockets and take more of your shit.

NEOSERF Wed, 08/09/2017 - 10:57 Permalink

If this was the year 1998, and your President was tweeting out nuclear fire and brimstone, the markets would be down 8-10% today to send a message to politicians that this was bad for business.  In 2017 with no humans trading, computers don't care about nuclear war unless it hits their NJ servers