With new issuance at dismal levels and investors gearing up for a three-day weekend, participants in the municipal bond market this week are focusing their attention on the impact of a second downgrade on Puerto Rico debt.
"Well, it's headlines on Puerto Rico again," one trader in Chicago said in an interview. "In a market calendar week that's very thin most of the discussion is about Puerto Rico and some of the ramifications of the downgrades."
Market participants are watching benchmark muni indexes including one by Barclays Plc in which Puerto Rico bonds represent 2.5% of the $1.28 trillion index, the trader said.
"We're going to see what might fall out of the indexes and how that might affect the overall market," the trader said. "There are mutual funds that are going to be forced to sell, depending on what the prospectuses allow. It's hard to quantify what the backstop is."
A two-notch downgrade by Moody's Investors Service brought Puerto Rico's general obligation rating to speculative-grade Ba2 from Baa3. The service also cut the commonwealth's Sales Tax Financing (COFINA) senior-lien bonds, considered a safer investment, to Baa1 from A2.
The move by Moody's follows a downgrade by Standard & Poor's on Tuesday that knocked the island's GOs one level to BB-plus from BBB-minus.
"There's a very light calendar to start this week with and I think people are going to see what goes on with Puerto Rico," a New York-based trader said. "Things looked kind of unchanged right now."
Potential volume in the coming week is estimated at $2.65 billion, compared with $3.53 billion in sales last week.
Traders on Friday said some retail investors began backing out of Puerto Rico bonds following the downgrade. Many of those traders left at the first signs of trouble last year, the trader said.
"A lot of retail selling came out last year but for anyone that's kind of kept their position since then that downgrade may force some people out," the New York-based trader said. "The quicker that hits mainstream retail the quicker you may see a knee-jerk reaction."
The downgrades are likely to have the most negative impact in the event of a bond sale by the island, traders said. Puerto Rico is expected to bring bonds to market by the end of the month, and some reports have suggested a private placement deal is in the works.
"It's not about the bonds today, the market's priced those," the Chicago-based trader said. "It's going to be about purchasing bonds at new prices and what kind of returns Puerto Rico can give investors."
Treasuries were mixed Monday, with the 30-year and 10-year yields slipping two basis points each to 3.66% and 2.67%, respectively. The two-year yield gained one basis point to 0.32%.
