Denmark Told to Fix Frozen Bond Market Amid Currency Battle

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Denmark’s efforts to prevent the krone strengthening beyond the confines of its peg to the euro are killing liquidity in its bond market.

That’s according to PFA A/S, the country’s biggest commercial pension fund and the owner of $14 billion in Danish bonds.

The central bank suspended government bond sales in January as part of a strategy to deter investors from hoarding AAA-rated krone assets after Denmark’s euro peg came under attack. While the bank’s efforts, which included cutting the key deposit rate to minus 0.75 percent, have stabilized the exchange rate, they’ve also created an “unsustainable” liquidity drain that’s punishing institutional investors, according to PFA.

“No one wants to be the first to go into an illiquid market,” Poul Kobberup, chief investment officer for fixed income at PFA, said in a phone interview. “It’s not a good thing for a large holder of papers in the Danish market to have an illiquid market.”

He says the distortions brought on by Denmark’s decision to halt debt sales are avoidable and is now urging the central bank to use its balance sheet to ensure the bond market doesn’t continue to suffer.

“Be more active in the market,” Kobberup said. “They have a huge portfolio in the market. Even if they’re not issuing, they could still go in and buy or sell papers, or change duration.”

Treasury Bills

The central bank resumed Treasury bill sales in March after rejecting all bids in three previous auctions. It received offers for almost eight times the 1.46 billion kroner ($200 million) it sold on Wednesday as investors try to crowd into the country’s only functioning government debt market.

The central bank declined to comment on when it might resume bond auctions. “Issuance of domestic and foreign bonds is suspended until further notice,” spokesman Karsten Biltoft said by e-mail.

The bank needs to expand its traditional role and take extraordinary steps to ensure liquidity in extraordinary times, Kobberup said.

“They should be a liquidity provider,” he said. “Then we’d get liquidity back into the market and lower rates with it.”

Without central bank issuance to sustain the market, primary dealers have left, leaving buyers and sellers to find each other and driving bid and ask spreads wider apart, Kobberup said.

Swap Market

“That illiquidity moves over to the swap market,” he said. “It’s only functioning because the buyers and sellers find each other. We have the same issue in the short-dated market and in the currency market as well.”

According to Jens Naervig Pedersen, senior analyst at Danske Bank A/S, using bond issuance as a monetary policy lever is a questionable move.

Danske Bank estimates Denmark will resume bond sales toward the end of this year or the start of 2016, though pressure to address the lack of liquidity may force the central bank to act earlier, Pedersen said.

“The norm for domestic debt issuance does not permit using bond sales for monetary purposes,” he said.

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