Agency spreads tighten as Freddie Mac skips sale; callables pick up on Treasury weakness

By Kenneth Lim

Boston, March 26 - Agency spreads narrowed slightly on robust volume Thursday as the market finally caught up with recent swap tightening.

Freddie Mac also helped to lift some supply pressure by choosing not to issue any Reference Notes this week.

Callables continued to dominate the agency market, with high issuance volume on Thursday on the back-up in rates.

Bullet spreads ended unchanged to slightly tighter, an agency trader said. Swaps widened by about 1 basis point on Thursday, although swap spreads on the week are still narrower.

"The last two days when we saw swap spreads tighten dramatically, we didn't see as much tightening in agency bullets," the trader said. "So I think agency bullets are just slowly catching up."

Volumes were good across the board because of current weakness in Treasury markets, the trader said.

"I think we're going to see continued follow-through [on Friday]," the trader said.

Freddie Mac also helped at the front end of the curve by choosing not to issue any Reference Notes on this week's calendar slot.

Some market participants had been expecting a two-year offering, although most investors did not see a big deal in the works. Freddie Mac's decision to skip the issuance window was not a big factor on Thursday, the trader said.

"I don't think it was too big a surprise," the trader said.

Callable issuance picks up

Callable issuance had a strong session on Thursday because of the higher rates made possible by the week's selling in Treasuries, the trader said.

"It was a very busy day today," the trader said. "[There were] a lot of new issues since obviously the Treasury market has sold off, so a lot of new coupons got printed in all sorts of structures...that's what's dominating right now."

A look at the trading screens showed three pages of new issues on Thursday, the trader added, which is above average.

Three factors combined to spur the furious printing of new callables, the trader said. First, rates have been climbing this week amid poor Treasury auction results. Many existing issues are also getting called, and a good amount of volume is coming as the market replaces the called securities. Finally, a lot of money is looking for a home.

"It's a combination of all three factors," the trader said.

Room to grow

The strong demand for callables could persist for some time, another trader said.

"We always get renewed interest every time there's a drop in Treasuries," the trader said. "For a few sessions, volatility has been hurting us and moving swap spreads, but that's three or four days of really just tempered enthusiasm... The absolute yields we're seeing is still good."

The trader said that as long as the yield curve stays north of 250 bps and political concerns remain the same, investors will still look for callables. The market is historically rich at the moment, but many other spread products are also expensive at the moment, and callables remain relatively attractive, the trader said.

"I think they're relatively rich compared to historical valuations, especially compared to bullets... but I think they're still cheap compared to other products out there," the trader said. "I think there are a lot of spread products that are tight historically compared to themselves, but if everything's tight, then you have to look around."

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