Fund Flows Revealed as Exposure to Krone Sinks After Peg Attack

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After exiting hedges designed to protect them from a sudden surge in the krone, Denmark’s pension funds are set to reduce their exposure to the currency even further in the coming months, Nykredit A/S estimates.

Pension funds sold 13 billion kroner ($1.9 billion) in Danish securities last month -- much of that in three-month forward contracts -- after dumping 22 billion kroner in June, Nykredit said, citing central bank data that’s not publicly available. The sales marked the first time funds have sold kroner this year, after accumulating 123 billion kroner since the start of January.

“There is still potential for further outflows from the pension and insurance companies,” Tore Stramer, an economist at Nykredit in Copenhagen, said by phone on Wednesday. That’s “simply because they were such big contributors to the inflows” earlier in the year, he said.

The development has freed Denmark to unwind record reserves once needed to defend its euro peg. The central bank sold foreign currency and bought 40.2 billion in kroner last month, marking one of the biggest such purchases on record and helping reverse a policy of dumping kroner earlier in the year, when speculators were hoarding the Danish currency.

Unlike Switzerland, Denmark ended up proving that policy makers can defeat markets intent on undermining their currency regimes. The central bank’s minus 0.75 percent deposit rate, record foreign reserves and a decision to halt government bond auctions all proved too much for hedge funds and other short-term investors, who retreated.

Reluctant Funds

But it is taking longer to persuade domestic pension funds they can safely unwind their hedges against a collapse of the peg. The institutional investors waited several months before starting to exit their insurance contracts.

Nordea Bank AB estimates that the shift in flows that has since taken place means Denmark is now preparing to normalize its monetary policy and scale back the negative rates that have punished its banks and inflated its housing market.

Thanks to continued krone sales from pension funds, “we will see a significant drop this month and next” in Denmark’s foreign reserves, Stramer said. With the latest transactions, Denmark has 583 billion kroner in reserves, compared with a March peak of 737 billion kroner.

Nykredit estimates the central bank “will soon reach the level of the beginning of the year,” before speculation started and when reserves were about 450 billion kroner. “We are almost there,” Stramer said. Once that happens, the bank will start raising rates. Bond auctions will resume “perhaps at the beginning of next year, at the latest,” he said.