Agency spreads widen amid Europe's debt problems; Freddie Mac could issue at front end

By Kenneth Lim

Boston, May 4 - Agency spreads widened slightly on Tuesday as renewed concerns about the debt burden of European countries sparked a rush out of risk products.

Bullet spreads shifted out by about 1 basis point across the yield curve, said Joseph J. Riley, senior managing director of institutional sales and trading at Mesirow Financial.

"We're probably back about 1 bp across the board today," he said. "It's a different atmosphere. I mean, people just don't seem to want to do very much of anything here."

Europe flares again

The market got nervous about debt problems facing Europe again on Tuesday after a weekend rescue deal for debt-laden Greece calmed investors on Monday.

Tuesday saw investors worried the bailout package would not be enough to stop a spillover into other European countries.

"Everyone's eyes are on Europe and what's going on there," Riley said. "The question is...are the European problems going to spread to a point where they will affect our markets? Are we pushing Treasury yields to unreasonable levels as a flight-to-quality, and how long will that last?"

The murmurings about more problems in Europe led to a rush for Treasuries and out of spread products, and trading volumes were extremely thin in agencies, Riley said.

"What market?" he said. "It's been ridiculous...Today was definitely a struggle."

One problem is that investors see the Treasury and agency markets as extremely rich at the moment.

"They're parking [money] there, but how much of it is real money?" Riley said. "The true money funds are reluctant to buy anything."

Amazingly, agency spreads could narrow even further if rates go up.

"Spreads between agencies and Treasuries are probably narrow somewhat...but as underlying yields rise, I'm sure spreads will narrow a touch," Riley said. "But right now I'm having trouble finding anything that looks attractive."

Freddie Mac deal ahead

Freddie Mac is expected to announce on Wednesday whether it will use its calendar slot to issue new Reference Notes.

The agency could announce an offering in the two- or three-year sector, as has been the trend among other recent benchmark issuances, Riley said. There was also talk that Freddie Mac could skip the issuance.

"I heard late today a rumor that it might be put off...but I'm still expecting an announcement tomorrow," Riley said. "All the guys I'm talking to are still expecting a two- or three-year."

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