Bond flow around the April mortgage bond auction could be another source of downwards pressure on EUR/DKK FX forwards along with high net position.
We reiterate our view that the EUR/DKK FX forward curve is currently trading at too high a level.
In April of the past two years we have seen a drop in foreigner's holdings of Danish bonds by DKK33bn and DKK63bn respectively (see chart 1). The drop coincides with the April auctions of mortgage bonds. The drop is partly due to lower supply of mortgage bonds and lower demand from USD-based investors due to a less attractive pick-up from the USD/DKK FX swap. We could likely see the same pattern in the bond market this year, where foreigners will receive around DKK50bn in redemptions amid lower supply.
As we stressed last year in FX Edge: Why did the EURDKK 3M (NYSE:MMM) XCCY basis tighten in April? , 19 July 2018, portfolio flows are an important determinant of EUR/DKK FX forwards along with changes in DKK liquidity; hence, the net position. If the pattern from the last two years repeats itself in April, we could therefore see some downward pressure on EUR/DKK FX forwards in April from this cause. However, bond flows should not be viewed in isolation since flows in stocks and money market instruments have mitigated some of the effect from the reduction in foreigners' holdings of Danish bonds in April in the previous two years - see chart 2.
In conjunction with April's mortgage bond auction, the debt management office will be buying DKK19bn in mortgage bonds to fund social housing and draw down its deposits at the central bank. That in turn will push the net position higher to around DKK240-245bn in the first half of April (see FX Strategy: Update on DKK net position , 18 January 2018). That will add another source of downwards pressure on EUR/DKK FX forwards in April. The EUR/DKK FX forward market is currently pricing 3M EUR/DKK FX forward to rise to around -0.18% from -0.20% in 3M and to trade in the -0.15% to -0.18% range the rest of the year (see chart 4). Based on the analysis above, this pricing looks too high in our view - see here for further detail FX Edge: DKK liquidity flood , 16 January 2019 .
