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Which approach is best?
Two affluent nations with very strong financial market economies which are not part of the Eurozone but had pegged their currency to the Euro, Switzerland and Denmark, have approached the trepidation with which the future of the Euro has been viewed recently in two completely polarizing methodologies.
Switzerland, home to one of the most organized and renowned traditional banking systems in the world, suddenly removed its 1.20 peg against the Euro on January 15, safeguarding its own sovereign currency but creating a dramatic acceleration in value against the Euro that many FX companies were exposed to vast negative client balances, some of whom did not survive in business past that day.
Denmark, by contrast, has taken the completely opposite route, doing everything it can to avoid its sovereign currency, the Krone, which is also pegged against the Euro, becoming a safe haven for investors by selling off significant reserves and cutting interest rates four times in a year.
The Danish Krone is pegged to the euro via the ERM II, the European Union’s exchange rate mechanism. Adoption of the euro is favored by the major political parties within the nation, however a 2000 referendum on joining the Eurozone was defeated with 46.8% voting yes and 53.2% voting against it, thus it maintains its peg fastidiously. The peg has existed in close to its current form for more than three decades, first relative to the German Mark, and later against the euro.
March drew to a close with Denmark’s central bank having refrained from intervening in the foreign-exchange market, in a sign that the national currency has stabilized against the euro following weeks of volatility brought on by the European Central Bank’s stimulus efforts.
The Wall Street Journal has reported this week that the Danish central bank has been battling to stabilize the exchange rate, its core task, since January, when the ECB announced a vast program of bond purchases, intended to bring economic growth, that sent the euro plummeting against other currencies. The central bank has also stated that it had intentionally stayed out of the foreign-exchange market last month.
Nationalbanken, the Danish central bank, stated yesterday that its foreign-exchange reserves remained at 737.1 billion kroner ($107.7 billion), an elevated level, after it sold a record amount of its own currency in January and February to weaken it.
Switzerland’s actions in January, whilst wreaking a degree of havoc and calling into question the entire risk management model of many FX firms, has indeed removed any risk of the Swiss Franc being embroiled in any depreciative precipices should the Eurozone struggle to maintain its precarious position with the Greek debt stifling progress and Mario Draghi’s resource-consuming bond-buying program now in full swing.
Back in February, Denmark’s central bank stated in an interview with Bloomberg that it would never unilaterally break the rules that Denmark abides by inside the European Union.
Hans Joergen Whitta-Jacobsen, Head of the Economic Council had stated at the time that he spoke to the media as “a way of expressing that the central bank would go very far and do whatever it takes” to save the peg.”
“I won’t comment on the comments of others,” Karsten Biltoft, the bank’s head of communications when approached by Reuters last month. “They have to be responsible for their own words. When we say we will do whatever it takes to defend the krone’s peg to the euro, then that is obviously within the boundaries of what is legal.”
The effect of this approach is that Switzerland’s national bank, which has a large percentage of private shareholder ownership, has maintained its vault-like reputation and the Swiss Franc remains a sought after currency, whereas the Danish Krone has been the subject of trading suspensions by a series of FX brokerages who perhaps view Denmark’s pledge to retain the peg on the Euro under all circumstances as a potentially high risk in terms of volatility, as well as inevitable concerns over liquidity.
Last month, Denmark considered the controversial measure of implementing temporary capital control laws, an action which has proved disastrous in every nation that has ever taken such a measure, as removing the free market economy often removes the desirability of doing business with said nation.
At the time, Jens Nordvig, Managing Director of Currency Research at Nomura Holdings, Inc. (TYO:8604) explained that while he doesn’t know how “credible” the report on capital controls is “the mere news that this is something that might be considered has caused a big reversal and I think that in itself might impact the psychology a lot.”
An interesting observation to note is that despite the hundreds of millions of dollars which FX industry participants were exposed to in January, Switzerland’s status is unharmed and the nation’s financial sector storms forth with its usual uninterrupted verve and vigor, whilst Denmark, keen not to send a ‘black swan’ into European waters, is being approached with trepidation by FX firms and investors alike, demonstrating that there is greater concern about a specific currency and its affecting factors than the actions of a central bank to save it from depreciation at all costs.
The Danish central bank’s only policy aim is to keep the euro’s exchange rate within 2.25% of 7.46038 Krone to control inflation and provide stability for domestic businesses that look to the Eurozone as an important export market, and it has no target for the inflation rate.
The independent cat will be among the Eurozone pigeons should Greece default on its reluctantly agreed repayment structure for its swingeing debt. Should this occur, Switzerland’s pre-emptive measures may well serve its economy well.