Danske Bank Tells Clients to Hedge Krone Risk as Gains Persist

  • Danish krone has strengthened to levels matching peg crisis
  • Risk of a Brexit exacerbating demand for AAA krone assets

Denmark’s biggest bank is urging pension fund clients to hedge for continued strength in the krone as the currency approaches levels last seen during a speculative attack against the AAA-rated country at the beginning of 2015.

The trading recommendation comes as both Danske Bank A/S and Nordea Bank AB, Scandinavia’s two biggest lenders, expect the central bank in Copenhagen to respond to the krone developments with currency interventions this month.

“The krone remains supported by upward pressure on short-term money-market interest rates, a relatively low net position and likely some safe-haven demand on the back of the uncertainty regarding potential spillover effects on the euro from the pending referendum on EU membership in the U.K.,” Jens Naervig Pedersen, a senior analyst at Danske Bank, said in a note.

Danske is advising hedges where the krone is trading at 7.46 per euro, or eight to 10 years into the future. The bank says that current positions on the one to two year horizon “may also be rolled forward” to eight to 10 years.

Denmark’s central bank uses interventions and interest rate adjustments to defend the krone’s peg to the euro. Demand for krone assets is showing signs of rising as the risk of a British exit from the European Union drives investors into markets perceived as safe. At about 7.44, the krone is trading very close to the 7.43 it reached just after Switzerland jettisoned its ties to the euro in January 2015, fanning conjecture Denmark might follow.

Lars Rohde said in an interview last week the bank hasn’t yet reached the lower bound of interest rates with its extreme measures. Its benchmark deposit rate is minus 0.65 percent following a 10 basis point hike in January. For most of last year, the rate was minus 0.75 percent and has been below zero for the better part of four years, marking a world record.

Rohde warned that any bets against Denmark’s currency peg were bound to fail. The central bank made a profit last year from its efforts to beat back speculators, a point that Rohde underscored during the interview.

But speculation has persisted that Denmark’s currency peg may be tested again as the risk of a British exit from the European Union rattles markets. Britons go to the polls to vote on a so-called Brexit on June 23. The probability of the “leave” side winning is about 19 percent, according to Bloomberg’s latest poll of polls.

Under Rohde, the krone hasn’t been allowed to strengthen beyond 7.4345, Pedersen said. The bank’s mandate is to defend a target of 7.46038 within a 2.25 percent band, though in practice it only allows much smaller swings. There is a “slight risk that we may see it fall to around 7.42,” Pedersen said.

Forward-rate contracts in the euro-krone market are “relatively unscathed” by the Danish currency’s recent strength in spot markets. “But if speculation in the market starts to mount that the central bank will need to sell kroner through FX interventions on a larger scale, then we should see FX forwards fall towards the levels from early April,” Pedersen said.

Denmark’s foreign currency reserves have come down about 45 percent since reaching a peak of 737 billion kroner ($111 billion) in March last year.

“As a consequence of the falling FX reserves, excess liquidity in the Danish money market has dropped simultaneously,” said Jan Stoerup Nielsen and Uffe Kalmar Hansen, analysts at Nordea. “In order to increase both excess liquidity and FX reserves, we expect the Danish central bank to show great patience in the current situation, thereby relying solely on intervention to prevent the Danish krone from depreciating further against the euro.”

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