The word is spreading: Denmark is not Switzerland

Since the SNB failed to maintain its CHF cap on 15 January no day goes by without new headlines about leveraged hedge funds betting against the EURDKK exchange rate band. Denmark's central bank has so far been able to fend the specs off quite successfully. As I wrote last week, the cases of Denmark and Switzerland are just too different and should not be compared due to two facts:

1) The DKK is part of the ERM II. That means both the Danish central bank and the ECB obligated themselves to defend the EURDKK tolerance band.

2) Denmark's economy is not nearly as solid as Switzerland's to justify that much DKK appreciation versus the euro even if the peg were to break down. Unlike the CHF, the DKK is no safe haven currency.

It's good to see that more people are trying to talk some sense into the EURDKK short speculators, like Marc Chandler did in his commentary on Seeking Alpha.

January 2015 Nonfarm Payrolls lift USD

Yesterday the U.S. Bureau of Labor Statistics (BLS) reported that total nonfarm payroll employment increased by 257,000 in January 2015 and that the unemployment rate rose to 5.7% from 5.6%. The market had been expecting an NFP release of roughly 228k, according to a Bloomberg survey of economists. In addition, the BLS revised the November 2014 NFP number to 423k from 353k. The preliminary December 2014 revision stands at 329k versus the original release of 252k. That suggests that more than 1 million jobs may have been added in the nonfarm labour market since October of last year, painting a more optimistic picture for the US labour market.

2014 Revisions in Nonfarm Employment
2014 Revisions in Nonfarm Employment (Source: U.S. Bureau of Labor Statistics)

The increase in the unemployment rate may surprise some analysts considering the strong NFP print, but the change may merely have been a result of a disproportionate 0.2% increase in the labour force participation rate (62.9% after 62.7% in December 2014), which is encouraging given that slightly more people are now looking for opportunities in the improving jobs market.

When the number came out at 1:30pm London time, the USDJPY exchange rate jumped almost instantly to Y119 all the way from Y117.2 and EURUSD fell more than one cent to $1.1311 from $1.1459. Currency traders certainly cannot complain about a lack of volatility in the FX market in January and the first days of February. Intraday swings and the return of lasting price trends have provided many trade opportunities for investors. I still expect EURUSD to trade somewhere between parity and $1.1 by the end of the year. The case is similar for USDJPY with the Bank of Japan still set on printing more money to aid its economy. The strong employment numbers from the United States put a possible first Fed rate hike in mid-2015 back on the table.

Why the DKK is different from the CHF

As soon as traders had digested the CHF turmoil, they began to turn their attention to another currency whose exchange rate is pegged to the euro: the Danish kroner. Many have surmised that Denmark's central bank would not be able to defend the peg once the ECB started its QE programme. Some analysts have even gone so far as to say EURDKK Short would be the "trade of the year 2015". However, the DKK peg is different from the CHF peg for one important reason: The Danish kroner has been part of the European Exchange Rate Mechanism ERM II since January 1999. The CHF peg, on the other hand, was only introduced temporarily in an attempt by the SNB to stop the franc's rapid appreciation relative to the euro, which had been under selling pressure from the 2010 riots in Greece up until Mario Draghi's "whatever it takes" pledge to protect the currency. That made the EURCHF floor a unilateral monetary policy tool.

Athough the standard ERM II fluctuation band is +/- 15%, it was decided that the EURDKK exchange rate must deviate no further than 2.25% from the central rate of 7.46038. Historically, maximum deviations have been closer to 1%.

While it is true that Denmark has not made any efforts to adopt the euro yet, there are no signs of the country leaving the Exchange Rate Mechanism either. ERM II puts the Danish central bank in a more comfortable spot than the SNB because according to the mechanism "intervention at the margin is, in principle, automatic and unlimited", meaning that both the ECB and the national central bank will intervene to prevent the currency from leaving the mutually agreed upon fluctuation band. Given that the EURDKK exchange rate peg was agreed upon bilaterally, it is far more likely that Denmark will be able to defend the currency peg with support from the ECB.

Nevertheless, the country's central bank must obviously intervene in the markets to do so. It has already lowered interest rates twice since 15 January (the benchmark deposit rate is currently -0.5%) and temporarily suspended bond sales until further notice, which is an unconventional way of reducing DKK demand by shutting down a channel through which investors could purchase kroners. The central bank is surely looking into further (and stronger) monetary policy measures just to be ready if hedge funds begin to seriously bet against the EURDKK floor.

Either way, EURDKK is an unlikely candidate for a trade idea at the moment. USDDKK will likely continue to go up, but expressing that view is pretty much the same as going EURUSD short, which is what I would consider to be a more likely candidate for "FX trade of the year 2015".

Macro factors that drove the markets in January

With the first month of the year behind I thought it would be interesting to take a quick look at three major macro themes in the markets at the moment:

Central bank actions -- January 2015 was a month that was dominated by central bank policy actions, most importantly by the ECB which announced a substantial €1,000bn quantitative easing programme on 22 January. However, ECB QE was foreshadowed by the SNB's 15 January decision to abandon the CHF cap, which caused extreme volatility in the foreign exchange market. The SNB apparently did not think it would be able to defend the EURCHF floor once the ECB would begin pumping euros into the economy. The ECB announcement was followed by Denmark's central bank to cut interest rates further into negative territory twice within two weeks. This was to be expected given that the DKK is also pegged to the EUR. Additional central bank actions were seen in Canada and Russia. Central banks were the predominant influence on the markets in 2014 and that is unlikely to change in 2015.

EURUSD January 2015 Chart

Increase in volatility -- Market participants had various negative macro drivers to worry about in January, most notably the drop in commodities prices, political uncertainties and (still) the state of the world economies. Implied volatility in equities, as measured by the VIX index, increased accordingly. The VIX shows first signs of an upward trend that may have started in the fourth quarter of 2014. The expected tightening of Fed monetary policy is certainly one factor behind the increase in volatility, but political frictions with Russia and the recent elections in Greece also weigh on investors' sentiment. Risk-off was a definite theme of January 2015. It also shows in the price of gold and capital flows into other safe haven assets.

01/02/2015 VIX Index Daily Chart

Divergent performance in equities -- However, the performance of national equity indices was more idiosyncratic, as demonstrated by the chart below. While the US stock market struggled somewhat in January, both the DAX and the EuroStoxx50 posted significant gains. Market participants begin to see the strong US dollar as a problem for US exports. In addition, the low price of oil hurts America's oil industry (US oil production is almost at an all-time high), although it certainly lifts a burden off consumers' wallets. As can be seen, European equities were helped particularly by the announcement of ECB QE on 22 January: The DAX has since established a plateau above 10,500 points while the SX5E has stayed above 3,300 points. The Athens Stock Exchange, on the other hand, gave up all of its gains in the last week of January in anticipation of and reaction to Syriza's election victory, which is a major source of uncertainty for the country's economy and the euro zone as a whole. The ASE ended the month at a low of 721.93.

January 2015 Stock Indices Performance Chart

ECB QE + Alexis Tsipras = EUR short

Mario Draghi surprised markets on Thursday by announcing that European national central banks would purchase €60bn worth of assets per month at least through September 2016, bringing the total amount above €1,000bn. Sidenote: On Wednesday, a number of €50bn had been leaked to the press ("sources") -- Draghi is indeed one crafty Italian who knows all about expectations and how to control them. Consequently, the euro fell sharply after the real number came out. The Friday closing price relative to the US dollar was just above the $1.12 support level; intraday lows were below $1.115.

Combine ECB QE with negative interest rates and a diverging Fed monetary policy, and you can only see one way for the EURUSD exchange rate to go: Further down. Last Sunday's target of $1.12 was admittedly reached faster than expected (after all, Draghi had not done his magic yet). So what is a likely next stop? The long-term chart dating back to the year 2000 tells us that there are no significant support levels between $1.1 and parity. After today's news of Alexis Tsipras emerging as the election winner in Greece, the EUR is already at $1.113 in early Asian trading. Taking into account the leftist politician's proclamation that the troika was finally "over", Greece once again spells trouble for Europe.

Conclusion: Stay EURUSD short with a take profit at $1.1 and a tight trailing stop-loss order (max 100 pips, say). If you are not positioned yet, wait out for a less oversold point of entry. Watch EURUSD futures net positioning and sell EURUSD rallies. After a pull-back, which can well extend towards $1.2, EURUSD will most likely resume its downtrend back to $1.1 and beyond.