DKK: Something is rotten in the state of Denmark..at least according to Hamlet...

I have fielded quit a few calls on the DKK over the past three weeks – todays in the Macro Digest I "answered" these calls once and for all:

 

https://www.tradingfloor.com/posts/macro-digest-reasons-to-be-fearful-heres-three-3598696

 

 

Something is rotten in the state of Denmark (At least according to Hamlet)

 

I have answered hundreds of calls on the Danish peg and here's my take:

 

There are three main points to observe, but first let's acknowledge that the Danish peg has been in place since 1982. Denmark's link to the deutschmark has served Denmark well. And you can rest assured for Denmark it's not the euro as such we are pegged to, it's Germany and it's been like that since day one!

 

1.) The Danish central bank is doing exactly what we expect from it and according to the rule book on pegs. Lowering, penalizing, increasing the cost of carry by taking rates down. For the central bankers it's a "time issue" – they feel they can do this longer than the market has time or patience for. They have a good track record having spent 270+ billion DKK during 2010-2012 and of course several interventions since 1982. I would wager – everything being equal – they could intervene easily for six month but also for 12 months, except that:

 

2.) The weakness of the DKK peg is not the DKK, but the EUR. Which make the analogy with Swiss central bank more acute. Should we see a Grexit and/or Brexit we would expect more pressure on the DKK. Foreign reserves are less than 30% of the balance sheet at present but could increase to unacceptable levels of 80-100% of GDP. The fight is basically: 'Time vs. Size of balance sheet of the Danish Central Bank'.

 

3.) The pertinent question however is: Why have a peg to EUR if Denmark never has any intention of joining the single currency? There needs to be a political discussion in Denmark on this issue, but I will wager that if push comes to shove Denmark would rather join the EUR than allow a 10% revaluation. The reason for has multiple explanations but the simplest one is the size of the Danish financial system. The pension sector on its own is 160% of GDP rising to 200% in the next twenty years. The liabilities is in DKK, but most of assets in EUR. The yield curve is in EUR. Elementary Dr. Watson!

 

Yes, it's a free option. Yes, the loss potential is small, but I have to admit I don't lose sleep over the DKK, knowing that should we have real issues we would probably be replacing Greece in the EURO if everything becomes unhinged.

 

 

Med venlig hilsen  |  Best regards
Steen Jakobsen  |  Chief Investment Officer

 

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