(Bloomberg) -- The world's biggest covered-bond market has seen a surge in foreign ownership, with Japanese investors in particular emerging as eager buyers.
Most recently, the offshore cash has flowed into the longest maturities in Denmark's $500 billion mortgage-backed bond market. Jacob Skinhoj, chief analyst at Nykredit Markets, says it's higher interest rates in the U.S. that are behind those flows.
“Japanese investors are starting to sell off U.S. assets,” Skinhoj said. Nykredit, Denmark's biggest mortgage bank, can see that bondholders based in Japan are increasing their presence in the Danish market “at least weekly,” he said.
Foreign investors' portfolio of Danish mortgage bonds
| Maturity | January 2016 | February 2018 |
|---|---|---|
| 1-3 years | 152 bln kroner | 73 bln kroner |
| 3-5 years | 141 bln kroner | 186 bln kroner |
| 5-10 years | 122 bln kroner | 127 bln kroner |
| Over 10 years | 176 bln kroner | 281 bln kroner |
| Source: Danish central bank |
According to Thomas Rasmussen, an analyst at Jyske Bank, foreign investors “are the buyers in the callable segment and they're controlling the pricing at the moment.” Central bank data show that offshore creditors hold almost a quarter of the Danish market.
International demand for Denmark's AAA-rated mortgage bonds has grown steadily since early 2015, when speculators targeted the Danish euro peg after successfully forcing Switzerland into a free float. Denmark beat back the attack by cutting its main interest rate to minus 0.75 percent, raising currency reserves to a record and halting government bond sales.
“When the Swiss gave up their peg to the euro back in 2015, the Danish central bank had to lower Danish rates immediately and very substantially,” Skinhoj said. As a result, “the FX forward from Japanese yen into Danish kroner is larger compared to the FX forward into euro.”
Skinhoj says Nykredit is also seeing more investor interest from inside the European Union, and there's a rise in European asset managers buying the bonds on behalf of Japanese investors.
The development may drive the price of Denmark's 2 percent callable bond due 2050 over par. That means mortgage banks would have to start offering bonds with a coupon of 1.5 percent, matching a record low.
Demand for Danish securities has helped inspire a European effort to create a more uniform market in the region for covered bonds. Systems vary across countries, and one of the aims of a proposed directive is to attract more investors from outside Europe.
The risk of foreign investors exiting is limited because of a key feature of the Danish market, according to Skinhoj. Borrowers can buy back the bonds and have done so, most recently in in 2008 when “we saw very huge buying,” he said. So should mortgage bond prices fall, the mechanism provides a built-in backstop for investors.
An increase of 1 percentage point in interest rates would slice 18 billion kroner off the value of foreign bondholders' holdings of fixed-rate bonds (as of February), according to the Danish central bank.
But if markets turn, investors “will be less stuck in Danish bonds compared to other foreign bonds,” Skinhoj said.
To contact the reporter on this story: Frances Schwartzkopff in Copenhagen at fschwartzko1@bloomberg.net.
To contact the editors responsible for this story: Tasneem Hanfi Brögger at tbrogger@bloomberg.net, Christian Wienberg
©2018 Bloomberg L.P.
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