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There’s a hidden warning in the Petrobras scandal — and it has nothing to do with corruption

Bonds of Brazilian corporates affected by the Petrobras corruption scandal have flunked in the last week. But prices jumping about at such speed tells us less about the credits in question than about a broader market malaise.

A corruption investigation at Brazilian oil company Petrobras is wreaking havoc on Brazilian bonds. Not only has the government-owned company’s well stocked curve widened hastily but the construction companies implicated in the investigation — Odebrecht, Queiroz Galvao and OAS — have also seen their debt prices nosedive.

OAS in particular suffered. Its $875m 2019 notes issued in June were quoted at a dollar price of above 90 on November 4 but were down to 22 on November 19.

Could OAS paper really have lost 75% of its value in just two weeks?

Well, no, not in the real world. Indeed, the reaction of Moody’s and Fitch to the scandal was relatively mild: they simply placed the builder’s rating on negative outlook.

According to one LatAm bond trader, the monumental plunge in OAS’s bond price comprised just five $1m trades, each pushing the quoted price down 10 or 15 points or so. In the words of his colleague on the syndicate desk: a “pathetic” market.

So while investors have indeed become nervous about corporate Brazil, and especially those companies reliant on Petrobras contracts or implicated in the crimes, there has hardly been a generalised move to dump the paper. The likelihood is that once the initial shock passes over, OAS bonds will recover to somewhere just shy of their value from earlier in the month.

Not that investors would have had the chance to dump OAS bonds en masse had they wished. Portfolio mangers would find themselves more handcuffed than a guilty Petrobras executive — and probably only slightly less ridiculed — should they try to sell more than a few million dollars of many of the LatAm corporate bonds out there.

Regulation restricting investment banks’ deployment of capital to hold bonds has hit secondary markets. And in any case, few traders are keen to risk throwing away their hard-earned cash this late in the year.

Investors frequently complain that only the large, regular LatAm corporate bond issuers have anything like liquid curves. Liquidity is close to zero in some of the $300m and below high yield deals to have made it through the market in the recent years of yield-chasing.

Nevertheless, the speed of the fall of OAS’ bond, and the tiny volumes of selling that have driven it, is still shocking.

This, however, is a reflection of international debt capital markets in 2014. In an October report, the Institute of International Finance denounced the “illusion of liquidity” created by a near-zero interest rate environment.

The IIF highlighted that the US bond market has grown from $33tr in 2008 to $38tr today, but that average daily trading volume has fallen from $1tr to $690bn. A widening of bid-ask spreads on EM bonds from 2bp-4bp in 2008 to 6bp-8bp today reveals the poor liquidity, it said.

So an isolated — and relatively light — anomaly like the Petrobras scandal can have such an effect, how will the market react to something really serious?

A Venezuela default, or even a rate rise by the US Federal Reserve — an inevitability at some point — will wreak havoc.There would not be a single capital market unaffected.

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