US: Puerto Rico bonds price in higher default risk - Westpac

Hurricane Maria’s devastating impact on Puerto Rico has received a lot less media coverage than Harvey or Irma but seems likely to have much greater long term impact than both, suggests Sean Callow, Research Analyst at Westpac.

Key Quotes

“Two weeks after Maria’s landfall, “most of the island’s residents still lack access to electricity and clean water.” In his visit this week, US president Trump told local officials that Puerto Rico “threw our budget a little out of whack” but we are yet to see just how much will be requested for relief spending in Texas, Florida and Puerto Rico. US 10 year Treasury yields have traded mostly around 2.31-2.36% this week, including yield highs since July, but haven’t accelerated.”

“More dramatic of course is Puerto Rico debt. As the chart shows, the benchmark 2035 PR municipal bond began to tumble from about 58 cents in the dollar as the storm approached to 44c on Tuesday. The price fell further after President Trump told Fox News that “they owe a lot of money to your friends on Wall Street, and we’re going to have to wipe that out.” Budget director Mulvaney later said “I wouldn’t take it word for word” so this remains to be seen. But it does add a layer of nerves to the broader muni bond market, which totals $3.8 trillion.”

“In terms of data momentum, we retain our optimism over US growth and what that should mean for the Fed. Most striking this week was the Sep non-manufacturing ISM survey, which surged to 59.8, a high since 2005. A negative hurricane impact should be evident in some national data near term e.g. Sep non-farm payrolls but the Fed will obviously look through this. The US dollar should therefore enjoy extra yield support.”

“Also helping Dollar Index is increased political risk premium in the Eurozone and UK. The pound as weakest in the G10 over the week as the Tories’ gaffes and divisions draw headlines. And as Tim notes on p5, intra-Eurozone bond spreads are showing signs of higher political risk premiums, with Spain a particular focus after the Catalan referendum. Another reason for the ECB to take its time tapering?”