Softened sanctions on North Korea

Investors returned from the weekend with a high appetite for risk assets, sending the S&P 500 to a new record high on Monday, with global equities edging higher across the board. Risk-on trading was driven by two factors; the absence of provocative actions from North Korea, and the fact that less damage was recorded by Hurricane Irma than previously estimated.

Although the United Nations Security Council stepped up sanctions against North Korea over its missile and nuclear programs, the UN’s actions do not seem to be leading to war. The less severe measures and comments from U.S. Ambassador Nikki Haley that Pyongyang had “not yet passed the point of no return,” are pointing towards negotiations, rather than military confrontation. Eliminating North Korea’s risk factor will be a positive development for financial markets, but as we have yet to find out the response from Kim Jong-un’s regime, we cannot assume negotiations are going to be successful.

The damage cost of Hurricane Irma has been dialed down significantly, as it was downgraded to a tropical storm on Monday morning. Over the weekend, total damage cost estimates had exceeded $200 billion, or approximately 1% of U.S. GDP; current estimates have revised this figure down to $50 billion. Insurance stocks were the prime beneficiaries yesterday, with the sector rising 1.8%.

Another factor helping equity markets is the belief that the Fed will refrain from raising rates again this year, due to the loss in economic activity caused by hurricanes Harvey and Irma. Investors are likely to continue buying stocks with overstretched valuations because when compared to treasuries, they still look much more attractive.

Safe haven assets were sold off heavily, with gold declining 2.3%, or $32, from Friday’s peak. Although the appetite for equities may further affect gold prices, investors are likely to remain cautious and hedge against many unknowns. That’s why we didn’t see any significant outflows from gold-backed exchange traded funds. The yellow metal is still up 10% from June’s low, and we expect the $1,300 will prove to be a strong support level.

Currency markets were steady early Tuesday, with the greenback holding on to most of yesterday’s gains. However, UK data might lead to some big swings in sterling if it diverges from expectations. The risk of the August CPI shooting higher and leading to a more hawkish tone from BoE on Thursday is keeping the British pound/U.S. dollar currencies (GBP/USD) well supported. With no other tier-one economic data on the calendar, currencies are likely to remain range-bound for the rest of the day, unless we see significant moves in U.S. treasury yields.