Though the bank stresses that such a scenario remains unlikely, UBS suggests that the Danish central bank could de-peg its currency from the euro should the eurozone’s fiscal crisis worsen. Investors are increasingly positioning to benefit from long-term krone appreciation through option buying, Walker adds. Low delta long-dated krone calls have been a popular strategy.
Under the second European Exchange Rate Mechanism initiative, the krone has been pegged to the euro at DKr7.46038, +/-2.25%, since 1999. It has not moved more than 0.5% either side of the fix in that time. Denmark's NationalBanken sets no formal interest-rate target.
From a macro point of view, Danish growth has lagged behind its Scandinavian peers, in part because of the inflexibility of its monetary policy, Walker argues. Aside from Portugal, Denmark is the only European country still in recession. Danish broad-money growth has been notably more volatile than that of the eurozone as a result
| Real GDP growth (year-on-year) Denmark, Sweden, Eurozone |
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| Source: UBS FX Strategy, Bloomberg |
A national referendum on euro membership slated for November this year has been scrapped, in the face of persistent national scepticism. A recent poll conducted by Danske Bank shows that just more a quarter of Danes would favour euro membership.
Any abandonment of the peg is likely to lead to short-term krone volatility, however. “The volatility surrounding an event of this magnitude in the short term would be immense,” Walker warns. “The political and logistical risks associated with such a significant regime change would likely provide significant headwinds for the DKK.”
Ordinarily, investors could be expected to buy EURDKK in a flight to liquidity. But if the euro were to break up, a neutral stance on EURDKK would be appropriate, given a widespread risk-off environment, the note adds.
Instead, the bank concludes, a better short-term trade in the event of a break-up would be to go long USDDKK, with the dollar benefiting from haven buying and from its relative isolation from the crisis’ epicentre.
Longer-term post break-up, buying the krone versus a Scandinavian and euro basket would leave investors well positioned for krone appreciation. Walker argues that more flexible NationalBanken policy would aid a return to GDP growth, and that the krone would probably appreciate relative to its Scandinavian peers.