Risk on' in financial markets has weighed on EUR/DKK the past week.
Danish investors have significantly increased their holdings of foreign equity in recent years and have thus become more exposed to fluctuations in equity markets.
We forecast EUR/DKK to fall to 7.4550 in 12M partly because we expect some further gains in global equities this year.
We have previously argued that one of the main drivers of EUR/DKK is the return on Danish investors' portfolio of foreign assets - e.g. see FX Edge Good reasons for higher EUR/DKK spot rate . This point can also help explain the development in EUR/DKK over the past week, where EUR/DKK has dropped close to the level of 7.4600. In DKK terms, Danish investors have seen a return of 8-12% on their holdings of European and US equities this year, which in turn means that Danish investors need to buy more DKK forward to rebalance FX hedges in order to keep an unchanged FX hedge ratio.
Chart 1 illustrates this point more fundamentally. It shows that Denmark has the fourth largest net position in foreign equity relative to GDP among major currencies (Norway stands out due to the effect of the petroleum fund). Hence, Denmark has the second largest outright exposure to the global equity market, which means that fluctuations in equity markets affect DKK to a larger extent, other things being equal. Denmark is accumulating significant savings, e.g. in pension funds these years, which can help explain the large position in equities. Over the past couple of years Danish investors have increased their holdings of foreign equity relative to foreign bonds.
The importance for EUR/DKK of movements in asset prices is further visible if we look at how the bouts of inflow and outflow into the central bank's FX reserve have coincided with development in global equity and fixed income markets - see chart 2 and 3. We note (1) the inflow in 2012 coincided with a sharp rally in German fixed income. At that time, Danish investors held more foreign bonds than equity. (2) The inflow and subsequent outflow in 2015 coincided with a sharp rally in both fixed income and equity markets and subsequent setback. (3) The inflow in 2016 came amid gains in equity and fixed income. (4) When equity markets slumped in Q4 last year, Denmark saw outflow from the FX reserve in December. The recovery in equity markets this year in turn has ended the need for FX intervention.
Based on this micro study we conclude that investor returns are an important driver for EUR/DKK and that now, on balance, equity returns play a greater role relative to returns on fixed income. We expect it will continue to be important this year. We forecast DKK to appreciate vis-à-vis EUR to 7.4550 in 12M partly because we expect some further gains in global equity markets. See FX Forecast Update for further detail on our view on EUR/DKK. Finally, note that the FX forward market is pricing EUR/DKK to fall towards the strong end of the historic trading range on 12M. 12M EUR/DKK FX forward outright is currently trading around 7.4460-70 and thus below our 12M forecast and slightly below the historic median for EUR/DKK spot.
