Agency spreads recover from early sell-off on Goldman complaint; short-term paper eyed

By Kenneth Lim

Boston, April 16 - Agency spreads recovered from early widening to end the day unchanged as risk instruments got a jolt from government accusations of past civil fraud at Goldman Sachs & Co.

Bullet spreads closed the day mostly flat as afternoon buying helped to pull the market back from an earlier slide.

"Agency spreads were a little wider on the initial news about Goldman Sachs because swap spreads were widening," said Christopher White, senior vice president of sales and trading at Moors & Cabot Capital Markets. "Spreads moved about 2 basis points wider in the morning, but in the afternoon we saw a little bit of a pullback, so things were essentially flat for the day."

Fannie Mae's new 1.25% two-year Benchmark Notes due 2012 ended the day flat at a spread of 22 bps over Treasuries, while Federal Home Loan Banks' 1.875% Global Notes due 2013 were last seen at about 19 bps over Treasuries on the offer side, White said.

Goldman Sachs spooks market

A languid market woke with a start on Friday on news that the Securities and Exchange Commission filed a civil lawsuit against Goldman Sachs alleging that the bank failed to disclose a conflict of interest in subprime mortgage investment products it sold.

The suit said that Goldman Sachs did not inform investors that a client that had shorted subprime mortgages had a hand in including those mortgages in investment products before the housing market crashed.

Goldman Sachs denied the charges.

"We are disappointed that the SEC would bring this action related to a single transaction in the face of an extensive record which establishes that the accusations are unfounded in law and fact," the bank said in a statement.

White said the news led to a spike in trading activity in an otherwise slow week for agencies.

"It was busy today," he said. "We had obviously some volume on the Goldman Sachs situation...The secondary market was again busy, good balance of flows."

He said the news did not appear to have any direct implications on agencies, but the negative sentiment surrounding the headlines led investors to initially cut their exposure to spread products.

"I think what happened was as the Street digested some of the Goldman news, and of course with any kind of these headline news you're going to take off some risk," White said. "So very, very macro people went in and took some risk off the table."

New confidence

Investors who had been waiting for some cheapening in the market saw an opportunity in the morning sell-off, helping to bring spreads back in, White said.

"Agencies saw a little bit of a sell-off just because people were laying off some risk, but then you saw some buying later this afternoon," he said. "We've seen people want it to get cheaper, which is maybe why you saw the bounce back in the afternoon."

The recent narrowing of agency spreads suggests that the market is less concerned now about the strength of the U.S. government's support for Fannie Mae and Freddie Mac in the short term, White added.

"I think people are getting more and more comfortable with the fact that the short end of the curve is going to continue to trade well for the near term, whereas I think some people thought the very short end was exposed to some risk previously that the Fed could change its language," he said.

But the Fed's recent actions and statements suggest that the central bank is not about to change its short-term policy on agencies quickly, White said.

"To me it seems like the Fed, if anything, is still worried about deflation in the short term," he said.

Developments in the Goldman Sachs case could set the tone as the new week begins, White said. Beyond that, Freddie Mac is scheduled to announce on Tuesday whether it will issue Reference Notes.

"Freddie Mac's coming with probably a three-year, maybe even a five-year," White said.

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