Bond Liquidity Dead in Denmark as Top Fund Considers Options

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After suspending government debt auctions since January, Denmark has watched the limited liquidity there was in its benchmark debt market disappear.

It’s a precarious situation to be in as bond markets deliver some of the most violent price jolts since the height of Europe’s debt crisis. But Denmark has been fighting a different battle, namely the defense of its euro peg. It stopped issuing debt four months ago to keep speculators out of the AAA rated krone market.

This week, the central bank tried to mitigate the liquidity freeze by allowing so-called switch auctions, in which investors can trade the bonds they hold for existing on-the-run series. The step won’t lead to an increase in volume. The biggest commercial fund in the country, $80 billion PFA Pension A/S, says the gesture won’t really help liquidity.

“It won’t solve the problem,” Christian Lage, chief investment officer at PFA in Copenhagen, which owns about $14 billion in Danish government bonds, said in a phone interview. “It’s just a small step.”

Back in January, when the central bank won the government’s permission to halt all its bond issuance, markets looked quite different. Yields on maturities as long as five years were negative and no matter what Denmark did, it couldn’t keep out speculators emboldened by Switzerland’s decision to abandon its ties to the euro.

Liquidity Trap

Now, the situation is quite different. What was once prized as a haven market is starting to look like a liquidity trap. The yield on Denmark’s 10-year bond now trades more than four times higher than a low of 0.2 percent in the middle of April. The bond has delivered investors a 5.7 percent loss in the period.

PFA says it’s not sure it will make use of the central bank’s switch auctions, for which dates and terms have yet to be released.

“We’re still considering our options,” Lage said. He would “welcome any step that would bring back liquidity to the Danish government bond market,” which he characterizes as having been “pretty dead” since January.

Turnover in Danish government bonds has dropped about 37 percent since the debt office suspended issuance, according to the Nasdaq OMX Copenhagen exchange. The data don’t include trades that aren’t reported to the bourse.

Helping Investors?

Nordea Bank AB, Scandinavia’s biggest lender, says the central bank probably won’t resume bond issuance until the third quarter. Denmark’s benchmark deposit rate, now minus 0.75 percent, is unlikely to be raised until the fourth, it says.

The central bank is signaling it’s in no hurry to accommodate bond investors. While the switch auctions were designed “to ease trading” because the bank “wanted to help the bond market,” spokesman Karsten Biltoft says policy makers “aren’t particularly concerned” about liquidity.

The switch auctions probably won’t influence bond prices but may reduce volatility, said Michael Liebak, chief analyst at Nykredit Markets. He says investors are likely to use the operations to switch into benchmark five- and 10-year notes.

“There is a pent-up need among investors for liquidity, so I think the program will meet some interest,” he said.

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