Denmark's $450 Billion Mortgage Market Tests Extreme Pricing

(Bloomberg) -- Danes may soon be able to get 30-year home loans at just 1.5 percent. That’s considerably less than many sovereign states pay to borrow for that period, including the U.S. government.

It’s not the first time Denmark’s mortgage-backed covered-bond market --the world’s biggest -- has tested such extreme levels. It tends to occur when investors from Germany to Japan worry about how to get reliable returns during unnervingly unpredictable times.

Danish mortgage bonds, which are mostly AAA-rated, have been drawing in more creditors from outside the country, with foreign ownership now at about a third of the 30-year segment. Foreign investors held more than a fifth of the total market, or roughly $100 billion, as of November.

A Crisis Metric

The price of bonds currently backing 2 percent 30-year mortgages climbed above par last week. If prices stay there, banks will soon need to start offering 1.5 percent loans instead. In the past, such low rates have only been available during extreme points in the economic cycle or in connection with sudden shocks, such as the speculative attack against Denmark’s euro peg that followed Switzerland’s capitulation into a free floating franc in early 2015.

Jeppe Borre, chief analyst at Totalkredit, which is part of Denmark’s biggest mortgage-bond issuer Nykredit, says the price for the 30-year bonds is now “at its highest ever since the introduction of the loan in the beginning of 2015.”

Borre also warns that things can change very suddenly.

“It’s impossible to say whether the trend holds above 100 in the short run,” he said, referring to the bonds now trading at par. “The market turmoil we’ve witnessed lately shows how fast things can go where risk aversion and flight to safety have been influencing markets.”

And unlike in 2015, when the Danish central bank was feverishly cutting rates and building foreign currency reserves to keep investors out, monetary policy is now on a tightening trajectory. The central bank bought kroner in December, marking the first time in three years that it’s intervened to support the currency. The move is seen as a first step toward hikes away from the extremes of negative rates.

Hedging Trends

Morten Hassing Povlsen, vice president for interest rates and currency strategy at Jyske Bank, says “money market normalization” is behind the weaker Danish krone. What’s more, pension funds and other investors have been under less pressure to build local currency hedges against their foreign portfolio holdings, as market declines have led to reduced values, he said.

At the longer end of the market, he says investor demand is strong for mortgage bonds. Even so, nothing is certain when it comes to interest rate predictions.

Christian Hilligsoe Heinig, chief economist at the mortgage arm of Danske Bank, says “there’s no doubt that the fear of an economic slowdown is steering rates markets.”

“Expectations for hikes from the Fed and the ECB are being scaled back in 2019,” he said. “As always, it’s difficult to predict the short-term swings in the financial markets.” But for now, it seems the economic upswing will continue into 2019, which means that 1.5 percent 30-year Danish mortgage loans will make only a fleeting appearance, at best, he said.

To contact the reporter on this story: Frances Schwartzkopff in Copenhagen at fschwartzko1@bloomberg.net

To contact the editor responsible for this story: Tasneem Hanfi Brögger at tbrogger@bloomberg.net

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