It’s not easy to price in the actions of dictators

YEONPYEONG island was obscured by smoke yesterday after North Korea launched an shell attack on the South Korean island, marking the greatest escalation of violence between the countries for decades. This is a dismal reminder that the line drawn between the two countries is still mired in dispute. It also caused the line on the graphs of the South Korean won to plummet after the news. Those who chased appreciation in the won could be painfully stung today. But how long will it last? Will the won recover?

In the recent past, the market has stoically ignored the skirmishes between the North and the South. The box below demonstrates that until recently the market barely reacted to these disputes. This changed when a South Korean navy vessel was sunk on 26 March. Initially, the event only had a limited impact on the market since it was not clear whether North Korea was complicit. In fact, over the period the won actually appreciated slightly. It wasn’t until a multi-national investigation concluded that a North Korean torpedo sunk the ship that the won took a dive. The dollar was then pushed up by around nine per cent in the following five days and then traded at elevated levels for the next two months.

The proximity of the two events and their escalation points to a period of increased uncertainty ahead for traders in the won. Analysts believe the attacks are being used by the dictator-in-waiting, Kim Jong Il’s third son, to demonstrate his strength to his soon-to-be party and army. The rating agency Fitch has recognised the impact of the leadership transition by stating that the hostilities are now within the bounds of “marginally increased risk.” Duncan Higgins of Caxton FX believes this will change the won trade: “Looking ahead we see further weakness for the won. Pressure from the South Korean public on the government to take action could quickly escalate the situation, leading to heavy selling of the won in the market.” Rationalising North Korea’s actions requires traders to predict the unpredictable. Those looking for a safe haven for their money should look elsewhere.

KOREA | MARKET REACTION

30 July 2006: exchange of fire near border post.
5-day move in dollar-won: +1.1 per cent

26 March 2010: sinking of South Korean naval vessel
5-day move in dollar-won: -1.1 per cent

20 May 2010: release of multinational report blaming North Korea for sinking of the South Korean naval vessel
5-day move in dollar-won: +9.1 per cent