This morning, North Korea fired what was likely to have been 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 it is 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 recently 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 indicated on 9 August. Kim Jong-un had said he was reconsidering this and the missiles into the Pacific could 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 that Pyongyang had ‘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 asked the 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. However, before this, 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 this time is not clear. However, a military strike does not seem likely.
A diplomatic solution will be difficult to find as it will involve on the one hand North Korean demanding an end to the annual military exercises, which will be difficult to obtain given that the US and South Korea see a big threat from North Korea. Similarly, the demand from the US for North Korea to back down from its nuclear ambition is also difficult as long as North Korea sees the US as a major threat. However, a diplomatic solution would be the best outcome, as a military conflict would entail severe losses on both sides. The road will not be easy and we are likely to see continued waves of escalations before the parties are finally 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. However, things are likely to calm down again soon and markets will 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, there is a risk that markets will find it hard to gain real momentum despite positive growth numbers overall at the moment.
