Credit Traders Rush to Hedge as Trade War Whips Bond Market

(Bloomberg) -- Fear gauges for the corporate bond market rose the most since March as jittery investors rushed to hedge their positions amid the escalating trade war between the U.S. and China.

The cost to protect a basket of high-yield company notes against default rose as much as 24.4 basis points Monday to 364.6 basis points, the biggest jump since March, according to the Markit CDX North America High Yield Index. Blue-chip company bond protection costs rose 5.2 basis points to 61.8 basis points. CDS index trading volumes as of Monday afternoon in New York were about triple typical levels.

The moves came as the deepening trade rift sent stocks tumbling toward their biggest drop of the year. Bonds tied to energy companies were among the biggest decliners as crude slid, and blue-chip debt tied to the likes of Apple Inc. and Dell Technologies Inc. was whacked as investors grew nervous about companies' exposure to China. High-grade investors rushed to hedge debt tied to communications giants like Cox Enterprises Inc., while high-yield buyers were most worried about energy companies including Transocean Ltd.

“We're seeing that while returns were very robust across fixed-income asset classes this year, it can unravel so incredibly quickly,” Jody Lurie, a corporate credit analyst at Janney Montgomery Scott, said in an interview on Bloomberg TV. “Investors who are continuing on that train of enjoying this credit risk have to be wary.”

U.S. company bonds have been one of the best trades in all of fixed-income this year, with risk premiums on investment-grade debt declining 0.4 percentage point through Friday. Total returns for the asset class were more than 11.3%, beating out even junk bonds, which had risen 10.2%.

High-yield bonds sold last week to healthy investor demand were broadly lower Monday. Notes miner Freeport-McMoRan Inc. sold at par on Aug. 1 now trade between 97 and 98 cents on the dollar, and Albertsons Cos and iHeartMedia Inc. have also seen their deals decline in secondary trading.

Now, investors looking to buy the dip are advocating looking at the parts of the corporate bond market that are traditionally considered the safest. The biggest winners on Monday included investment-grade healthcare companies like Eli Lilly & Co. and UnitedHealth Group Inc. and industrial havens like Waste Management Inc. and Ingersoll-Rand Plc.

“This has really caught the market off-guard,” said John McClain, a high-yield portfolio manager at Diamond Hill Capital Management. “We could definitely see an acceleration in the sell-off, so people should be sticking to high quality businesses and more defensive bonds.”

Christian Hoffmann, a portfolio manager at Thornburg Investment Management, said he wasn't tempted to buy the dip in risky high-yield debt. WTI crude prices dropped more than 1.5% Monday to under $55 a barrel, making many lower-rated energy companies the market's biggest decliners.

“If you want to buy the worst names in energy, those names are very much on offer,” Hoffmann said. “But we don't.”

--With assistance from Natalie Harrison, Gowri Gurumurthy and Michael Gambale.

To contact the reporters on this story: Caleb Mutua in New York at dmutua@bloomberg.net;Katrina Lewis in New York at klewis128@bloomberg.net;Claire Boston in New York at cboston6@bloomberg.net

To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoft@bloomberg.net, Boris Korby

©2019 Bloomberg L.P.