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.

EURUSD temporarily below $1.15 ahead of ECB

EURUSD Monthly 2015-01-16The EUR ended this year's second full trading week at $1.1567, after having briefly fallen below $1.15 on Friday.

The euro's depreciation had accelerated following the Swiss National Bank's surprise decision to abandon its cap on the value of the CHF relative to the EUR. Market participants have interpreted the SNB's move as further evidence that Mario Draghi will likely announce an ECB QE programme on Thursday. According to press reports, Draghi has already proposed a concrete QE plan to Angela Merkel and her finance minister Wolfgang Schäuble to ease German worries about a collectivisation of European countries' government debt.

But whether the ECB will start QE is not the only open question. The size of any such QE programme is another unknown variable that could ultimately take currency traders by surprise: The ECB said it was going to expand its balance sheet to €3 trillion. Its assets currently stand at roughly €2.17 trillion, which means that the ECB will have to purchase up to €830bn in government debt. Rumour has it, however, that the European national central banks might only flood the markets with €500bn as a first step and that the remainder or even another €500bn worth of assets will be purchased as part of a second QE programme if necessary. As said, those are only rumours at this point, but they are not far-fetched considering that the German Bundesbank remains very sceptical about asset purchases and may thus feel more comfortable with a smaller QE programme.

At least the above chart tells a clear story: The EURUSD exchange rate is pretty much stuck in one-way traffic at the moment. Unless the ECB disappoints next week, the next significant stop will be near $1.12. Despite extreme EUR short positioning in the market, the EUR is not all that much oversold versus the USD from a technical point of view, yet. Stay EUR short or wait for a turnaround signal, but keep up to date on any news about ECB easing measures as they will likely cause some volatility in the run-up to Mario Draghi's press conference on Thursday; a smaller-than-expected QE programme will squeeze EUR shorts.

Norway to buy 250m kroner per day

EURNOK Intraday 2014-09-30Following today's announcement that Norway would start purchasing NOK 250 million per day in October using foreign currency from its oil revenue accounts, the krone appreciated roughly 1%. EURNOK is currently at 8.1164, USDNOK is at 6.4273.

This is not a game changer. NOK 250 million equals only USD 36 million, and Norges Bank Governor Oeystein Olsen noted that this was neither a policy shift nor an intervention aimed at influencing the exchange rate. The central bank was merely reacting to current kroner flows, he added.