Mounting Risks Starting to Stick to South Korea’s Teflon Markets

The domestic and global risks that have been looming over South Korea may finally be catching up with its previously bulletproof markets.

After capping a record eight straight months of gains through July, the country’s benchmark Kospi Index is down in August amid a wave of fresh bad news that’s triggered a surge in volatility: 

  • North Korea condemned the latest round of United Nations sanctions Monday and vowed it will make the U.S. “pay dearly”, according to the Korean Central News Agency.
  • South Korean President Moon Jae-in’s administration unveiled proposed tax hikes Aug. 2 on large corporations and high earners as his reform push gets into gear. The Kospi tumbled as much as 2.2 percent, the most since November 2016.
  • South Korean prosecutor Park Young-soo has demanded a 12-year prison sentence for Samsung Group’s Jay Y. Lee for his alleged role in a bribery scandal that also toppled former president Park Geun-hye.
  • South Korea’s manufacturing purchasing managers’ index returned to contraction in July, according to an Aug. 1 reading, after expanding for the first time this year in June.

“Geopolitical risks will rise after the UN sanctions,” analysts led by Jaechul Chang, chief economist at KB Securities, said in an August 6 report. “This is based on the history that North Korea has railed against the sanctions against them and have carried out additional military provocations.”

Military tensions tend to rise in August and September, said Chang, with North Korea conducting a nuclear test on Sept. 9 last year to commemorate the country’s founding. Throw in the wildcard that is U.S. President Donald Trump and it’s impossible to rule out further ballistic missile launches or nuclear tests until early to mid-September, Chang said.

Read more: Asia’s Best Market Is Right Next Door to a Nuclear Nightmare

Here’s a look at some of the cracks starting to appear on South Korea’s facade:

Yields on 10-year South Korean debt have climbed seven basis points in August, with the potential to go higher on rising geopolitical risks, Chang said. Foreign fund flows are more sensitive to geopolitical risks and investors will need to watch for rising volatility around joint military exercises later this month, he said.

Expectations for volatility in Korean equity prices are climbing, with the Kospi 200 Volatility Index that tracks the largest companies up 27 percent since the recent low on July 21. The measure dipped at the start of this month before jumping again after Moon’s tax proposal announcement.

The Korean won, meanwhile, has lost 1.1 percent against the dollar since climbing to a nine-month high in July.

Yumi Kim, economist and strategist with Kiwoom Securities, said investors have become used to the presence of North Korea risk and expects the currency to trade in the 1,120 won range, close to its current level of 1,124.4.

KB Securities’ Chang is less sanguine, seeing potential for the currency to reach as high as 1,150 won per dollar in the short term before pulling back to its current range “as long as there’s no serious military conflict.”

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