The appeal of the Danish krone is growing as securities denominated in the Nordic nation’s currency offer a hedge against the risk of a euro-area breakup that even German assets can’t provide.
“For an international investor with euro-zone exposure, buying Danish assets can be a hedge against the extreme scenario of the euro breaking up,” Ian Stannard, chief European currency strategist at Morgan Stanley in London, said in a phone interview. “In that scenario, the Danish asset may appreciate and work as a hedge against the drop in the euro-zone asset.”
The calculation helps explain why investors are willing to pay the Danish government to hold its two-year debt, and why the minus 0.2 percent the central bank has offered since a July 5 rate cut still attracted 147 billion kroner ($24 billion) in deposits as of yesterday. The krone bet is making it harder for Denmark, which defends a peg to the euro, to fight off a capital influx as investors flee the euro zone’s deepening debt crisis.
In the event of a breakup, “you will know what you own if you have a Danish asset,” Stannard said. “Whereas you don’t really know what you’re left with if you own a euro-zone, and even a German, asset.”
The yield on Denmark’s two-year note dropped to a record low of minus 0.225 percent in Copenhagen. The 2 percent November 2014 note yielded 23 basis points less than similar-maturity German bunds, the biggest negative difference on record, according to data compiled by Bloomberg.
“What’s happening in Denmark is an indication of just how severe the euro crisis is,” Paul Krugman, the Nobel laureate and Princeton University professor, wrote today in his New York Times column. The crisis is “so severe that people are willing to pay to have their money stored somewhere else,” he said.
While the risk of a euro-area breakup remains remote, according to Morgan Stanley, economists are growing more accustomed to watching unlikely scenarios play out in reality. Danish central bank Governor Nils Bernstein said last week he never imagined he’d need to cut rates below zero.
The bank is now navigating “uncharted territory,” Bernstein said in a July 5 interview. “I hadn’t expected that. It’s the first time in this institution’s nearly 200-year history, so obviously I hadn’t expected it.”
The krone, which fell to the weakest since November immediately after the July 5 interest rate reductions, has since strengthened and is almost back at the same level as before the central bank’s cuts. The currency strengthened to 7.4368 against the euro today at 8:42 p.m. local time, compared with 7.4367 on July 4, according to prices available on Bloomberg.
Now that negative rates are a reality, investors and economists are wondering what’s next. Danske Bank A/S, the country’s biggest lender, said last month it’s started a risk scenario that envisages Denmark abandoning its peg should the cost of fighting currency appreciation grow too high. Though the bank doesn’t view this as a likely outcome, it’s no longer unthinkable.
According to Neil Jones, head of European hedge-fund sales at Mizuho Corporate Bank Ltd. in London, Denmark is one of a small group of havens left in which investors feel safe. That may put unprecedented pressure on the currency peg as more investors pile in.
“If you’re holding cash and fearing a break-up of the euro-zone it makes good sense to park your money in Denmark, even at negative rates,” Jones said in a phone interview.
There is a 53.5 percent risk that a country using the euro will leave the monetary union before the end of 2013, according to Dublin-based Intrade.com. Wagers on a euro exit by the end of this year indicate a 27.3 percent chance, according to yesterday’s odds.
Denmark’s government debt will reach about 41 percent of gross domestic product this year, or less than half the euro-area average, the European Commission said on May 11. The government in May cut its budget deficit estimate for this year, and said the shortfall will shrink to 1.7 percent of GDP next year, within the European Union’s 3 percent threshold.
The central bank’s debt management department, which handles bond issuance on behalf of the government, last month raised its 2012 debt sale target by 33 percent to 100 billion kroner to take advantage of falling yields. The extra liquidity may make the krone-bond market more appealing to investors.
At the moment, “there’s a limit to the number of assets that can be used for such a hedge,” Stannard said.
Denmark, which posted a record current account surplus in May, has an agreement with the European Central Bank to let the krone swing no more than 2.25 percent from central rate of 7.46038, though it maintains a tighter band in practice.
Denmark’s foreign reserves climbed to an all-time high of 511.6 billion kroner in June amid record interventions. That was followed on July 5 by unprecedented rate cuts that brought the deposit rate below zero and the benchmark lending rate to 0.2 percent.
“The global market is running out of havens that can guarantee investors getting their money back,” Jones at Mizuho said. “That makes the pressure on the havens that do exist even greater, escalating the situation. A euro-zone breakup would only extend that safe haven trade.”