From Puerto Rico to Greece, credit traders put on the defensive

[ATHENS] A day before debt traders closed the books on the first half of 2015, the dual threats of default by Greece and Puerto Rico spurred them into defense mode.

Trading in insurance-like contracts surged to the most in at least three months on Monday as investors and banks sought to preserve what little gains they still had for the year. The biggest exchange-traded fund that buys junk bonds dropped to the lowest level since December. And measures of credit risk in both Europe and the US jumped.

The activity underscored the uneasiness of investors already grappling with a Federal Reserve that's planning its first interest-rate increase in nine years. By the time trading started Monday in London, they also were faced with capital controls and a government-imposed bank shutdown in Greece, in addition to a Puerto Rico governor who warned holders of its US$72 billion of debt to brace for losses.

"There is a lot to deal with," said Andrew Brenner, the head of international fixed-income for National Alliance Capital Markets. "You don't know if you will have contagion or not. The whole situation is hard to gauge. And the Puerto Rico story complicated an already uncertain atmosphere."

About US$38 billion of credit insurance was traded Monday through benchmark credit-default swaps indexes from New York to Tokyo, Bloomberg data show. The cost to protect against losses on the debt in Europe jumped to the highest level since March 14, climbing 10 basis points to 76.4 basis points. The US gauge climbed 4.6 to 72, the biggest increase in that measure since oil prices plunged in October.

BlackRock Inc's iShares iBoxx High Yield Corporate Bond ETF, the largest junk-bond exchange-traded fund, fell 0.7 per cent to US$88.38, the lowest since Dec 16.

Investors in US$10.1 trillion of corporate bonds worldwide had already given up most of their gains for the year, with the Bank of America Merrill Lynch Global Corporate & High Yield Index returning 0.25 per cent through Monday. That's after having been up as much as 3 per cent in April.

Trading on Monday was more about preserving returns rather than any wide-scale selling, and money managers said there were no signs that anyone was being forced to sell.

The US$10.3 billion of dollar-denominated corporate bonds that exchanged hands was the lowest in more than a week, according to Trace, the Financial Industry Regulatory Authority's bond-price reporting system.

"Beyond knee-jerk reactions, the response in fixed income markets have been fairly orderly," Ben Christensen, a money manager at JPMorgan Chase & Co.'s asset-management unit, which oversees US$400 billion of fixed-income assets globally, said in a telephone interview.

US Treasuries, typically a haven when risk increases, yielded 2.32 per cent for 10-year securities on Monday, just below the level a week ago. The US two-year interest-rate swap spread, a key measure of risk for banks, rose Monday only to a high matched last week.

"Holding steady seems to be the best course," said Gregory Turnbull Schwartz, a money manager in Edinburgh at Kames Capital, which manages about 55 billion pounds (S$117.1 billion). With the end of the second quarter at hand, investors are in no mood to take additional risk "and then have to mark to market when everything is falling," he said.

The tepid trading volume in corporate securities contrasted with a surge of activity in credit derivatives, where investors often turn to protect themselves without unloading their holdings.

About US$14.2 billion of contracts were traded on a benchmark US investment-grade debt index, 161 per cent more than what's typical for recent Mondays, Bloomberg data show. About US$9.5 billion traded on Europe's benchmark, or more than double its average volume.

Greece sent shock waves through markets globally after the government took measures to prevent the collapse of its financial system. Months of debt negotiations were derailed after Prime Minister Alexis Tsipras called a July 5 referendum on austerity measures demanded by its creditors.

In Puerto Rico, where Governor Alejandro Garcia Padilla had previously said the commonwealth would do whatever it takes to avoid default, bondholders were surprised by a New York Times article Sunday night in which he said the commonwealth's obligations were "not payable." "It's an emotional issue where feelings are running very high and hot, and it's hard to trade when everything is about politics and emotion," said Donald Ellenberger, who oversees about US$10 billion as head of multi-sector strategies at Federated Investors in Pittsburgh. "As long as these crises stay contained then this is a good place to add risk. But that's a big assumption."

BLOOMBERG