UBS Asset Management Taps Derivatives to Hedge U.S. Debt Risk

UBS Global Asset Management, a money manager that oversees $644 billion, said it bought Treasury options to protect against losses from a U.S. default should lawmakers fail to agree on raising the nation’s debt ceiling.

The company bought puts on two-year Treasuries and sold those on German two-year note futures to mitigate the risk, according to Brian Fehrenbach, the company’s Chicago-based co-head of U.S. multi-sector fixed income. Puts grant investors the right to sell an asset.

“That’s part of our defensive strategy and it’s something we hope will not be tested,” Fehrenbach, a former derivatives trader for Bank of America Corp., said in an interview in London yesterday. “The uncertainty in Washington doesn’t promote confidence. The longer they go without a resolution, the more risk there is for a last-minute mistake.”

U.S. lawmakers are yet to break a deadlock on the debt limit, which Treasury Secretary Jacob J. Lew said would be reached on Oct. 17. Politicians yesterday embraced for the first time the possibility of a short-term deal. Failure to reach an agreement could lead to delays in payments to Treasuries holders.

Rates on one-month Treasury bills rose to the highest since 2008 on Oct. 8 as the U.S. government entered its second week of a shutdown caused by the collapse of Congressional talks on a federal budget.

The one-month TED spread showed the U.S. government is paying more to borrow money than banks for the first time since Bloomberg started collecting the data in 2001. It was at minus 10 basis points after reaching minus 16 two days ago

‘Tail Risk’

“There is a tail risk,” said Fehrenbach. “We perhaps give a higher probability for mistakes happening than other market participants, but I still think the base case that makes sense to us is that at the 11th hour a solution will be found.”

UBS Global Asset Management said it prefers European bonds to Treasuries regardless of the debt-ceiling debate given the U.S. Federal Reserve is closer to reducing stimulus in the economy than the European Central Bank.

“We have a net-short duration position in the U.S. and net-long duration in European interest rates,” said Fehrenbach. “The base-case scenario for us is for the ECB to be on hold for a while, and we can probably argue they should cut rates. The U.S. is closer to rate normalization than in Europe.”

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