Investors are on the hunt for larger cash holdings in portfolios, and as several pockets of the credit market are lacking prices, liquid assets are being sold. This is affecting influential mortgage bond offerings.
In just two days, the value of fixed-rate, 30-year 0.5 percent mortgage bonds has fallen from DKK 97.87 to 96.52.
Several conditions are cushioning the blow, however.
A number of market players have told FinansWatch that the market movements remind them of the fall of 2008, when due to a lack of prices on risky assets, investors sold highly lucrative Danish mortgage bonds at a time when rational economic intuition should have led to opposite behavior.
Although the market activity is causing concern, it is not in the same league as in 2008, says chief analyst and Ph.D. Jens Peter Sørensen from Danske Bank.
"The range of mortgage bonds is much bigger than in 2008, where there were really just two options - 1-year with interest adjustment and 30-year fixed rate bonds," he says.
Sørensen highlights that the value of 30-year bonds with a 2 percent coupon rate of interest has risen. The shorter, interest rate adjustable bonds are stable. Investors also have more internal options on the mortgage bond market.
"We are seeing a bit of stress on the market, but significantly less than in 2008. Danish government bonds are very close to the German ones," he says.
Negative rates make the alternatives to mortgage bonds less attractive
Comparable markets like the Netherlands and Finland have found that interest rates are moving further away from those in Germany. If the range of interest rates increases, this shows that there is more concern over the economy. According to Sørensen, it also shows that confidence in the Danish economy is high, and public finances are "super strong".
"I would almost call it impressive," he says.
Negative rates are also playing an important role. For investors wanting to sell mortgage bonds, they don't have a lot of options when reallocating funds, simply due to a lack of prices. There is little sense in having funds sit in accounts with -0.75 percent interest rates.
The effects of the financial crisis came to a head at a huge adjustment auction, which was the final straw for falling valuations. Today, auctions are spread out throughout the year.
Japanese investors pulling out
The big question is how the big purchasers of Danish mortgage bonds - institutional investors from Japan - have reacted over the past few weeks. Japanese investors bought slightly fewer foreign bonds in February, suggesting lower purchasing levels than previously, the latest figures from Bank of Japan show.
"Danish mortgage bonds have underperformed. That could be related to the fact that Japanese investors, who own a large portion of the fixed-rate bonds, are notorious for pulling back to their home markets in times of stress," says Andreas Steno, global strategist at Nordea.
"But I have no concrete evidence that they have sold bonds," he adds.
Steno believes that there has been a foundational shift towards having cash holdings.
"At the moment, there are essentially no financial assets that are doing well. Goods, equity, bonds - everything is under pressure. Cash is king," he says.
The whole system is lacking liquidity
The lack of liquidity in the system as a whole, including on the US treasuries market, is contributing to the large price fluctuations, which in the short-term, can imply that the market is overreacting to the fundamental negative effects on the economy.
"The downturn does not need to reflect very large sales orders. The normal flow on both sides of a deal are not there," says Steno.
His main scenario, however, is that the market fears a liquidity and financing crisis.
Lars Skovgaard Andersen, senior investment strategist from Danske Bank Wealth Management, reports that there are problems with the prices of the poorest rated corporate bonds in the high-yield space.
"The weakest bonds are not being priced. When investors can't get rid of the worst-rated bonds, they need to sell the most creditworthy. You can be forced to sell," he says.
This post originally appeared on AM Watch.
