Speculation Against Denmark’s Euro Peg Proving Relentless

by Christian Wienberg

Lars Rohde, governor of Denmark's central bank, says he’s ready to purchase government and mortgage bonds directly in the market should such steps prove necessary. Photographer: Freya Ingrid Morales/Bloomberg

(Bloomberg) -- Less than a week after Denmark resorted to its deepest rate cut ever amid historic currency interventions, forward rates suggest some traders and investors still aren’t convinced the central bank can save its euro peg.
SEB AB, the largest Nordic currency trader, says capital flows into AAA-rated Denmark forced the central bank to dump about $4.6 billion in kroner in the first three days of February alone, almost a third the record amount it sold in all of January. Nordea Bank AB, Scandinavia’s biggest lender, says Denmark will need to deliver another 25 basis-point cut to fight back demand for kroner, bringing the benchmark deposit rate to minus 1 percent.
“The pressure on the krone hasn’t eased yet,” Jens Naervig Pedersen, an economist at Danske Bank A/S in Copenhagen, said by phone. “We can see from the forward rates that the market views the current upward pressure on the krone as the greatest ever.”

Governor Lars Rohde addressed speculators last week in
what he characterized as a verbal intervention to persuade them he won’t let the krone’s peg to the euro collapse. Such a scenario is “unthinkable” and the central bank will do “whatever it takes” to avoid it, he said after delivering a fourth rate cut in less than three weeks.
Denmark’s largest institutional investor, ATP, sent a clear message of trust in the peg the same day, revealing it hasn’t bothered to hedge its $110 billion in assets against the possibility that the nation’s currency regime might break.

‘Ample Ammunition’

“The central bank has ample ammunition and we’re very comfortable with the situation,” ATP Chief Executive Officer Carsten Stendevad said in an interview.
Yet according to Lars Peter Lilleore, chief analyst at Nordea Markets in Copenhagen, betting against the krone is still attractive “if you’re a real speculator.”
Twelve-month forward-rate contracts traded at about 7.39 kroner per euro on Monday. That’s stronger than any closing spot price recorded since 1999 and about 1 percent above the 7.46038 rate the central bank targets. One euro cost 7.4441 kroner as of 11:14 a.m. in Copenhagen.
For investors who don’t offset their trades in the forward market, simply holding three-month Danish Treasury bills offers an inexpensive bet against the peg, Lilleore said.
The bills trade at a minus 0.8 percent annualized yield, or about 0.6 of a percentage point less than similar-maturity German bills. Based on an assumption that the krone will surge 20 percent if the peg breaks, like the Swiss franc did, it’s a cheap way to speculate, according to Lilleore.

‘Pay-Off’

“It’s a bet with a low probability, but with a high pay-off,” he said by phone. “It’s not nearly as good a bet as it was a few weeks ago, because the central bank’s efforts have had an effect, but it’s still a bet that’s a possibility.”
The central bank defends the krone’s peg against the euro in an official 2.25 percent tolerance band. In practice, it never lets the currency swing more than 0.5 percent around the target. It’s unlikely to deviate from that pattern, according to Danske, which is a primary dealer with the central bank.
“The current forward rate of 7.39 shows there are people speculating that, while the krone won’t break the peg, the central bank will have to allow bigger swings from the parity than it historically has allowed,” Pedersen said.

Swiss Fallout

Denmark’s biggest bank is telling clients this is an unlikely scenario. “It would invite unnecessary speculation against the peg because some investors might think this means the central bank is running out of options,” he said.
Since the Swiss National Bank abandoned its cap against the euro on Jan. 15, Rohde has struggled to fight back capital flows into Denmark amid speculation its peg to the euro would be next to fall.
The government, the opposition, business leaders and pension funds all support Denmark’s three-decades-old euro peg, which before being tied to the euro was based on the deutschmark. Rohde said Thursday he has unlimited resources with which to defend Denmark’s currency regime.
So far, he has sold kroner to bring foreign reserves to about 30 percent of Denmark’s gross domestic product. That’s less than half the 80 percent Switzerland held before abandoning its euro cap. Denmark has also suspended government bond sales to limit supply and drive down longer yields.
Rohde says he’s ready to purchase government and mortgage bonds directly in the market should such steps prove necessary. The bank can’t rule anything out, he said last week. Extreme monetary stimulus may also help Denmark fight the threat of deflation. Consumer prices fell 0.1 percent in January from a year earlier, the first annual decline since 1954, a report showed today.

Unwinding Bets

Pressure on the krone has risen as the European Central Bank, which backs Denmark’s euro peg through an agreement to provide “automatic and unlimited” support, embarks on an unprecedented quantitative easing program.
The relentless pressure on the krone may force Rohde to err on the side of caution, according to Nordea.
“I wouldn’t be surprised if the central bank cut rates even if krone pressure shows signs of easing, because the bank may want to flush out speculators,” Lilleore said.
The next challenge then comes when bets on the krone reverse and the central bank needs to unwind its record currency reserves,’’ according to Sydbank A/S.
“If there are too many kroner out there, they may come back very suddenly and in big lumps that will prove challenging for the central bank to handle,” Peter Bojsen Jakobsen, an economist at Sydbank, said by phone.