Agency spreads widen on persistent European fears; Freddie Mac front-end offering likely

By Kenneth Lim

Boston, May 25 - Agency spreads clawed back from intraday widening on Tuesday but still ended at a higher premium to Treasuries following a wild day in equities.

Bullet spreads closed about 1 basis point wider at the front end of the yield curve.

It was a "topsy-turvy day," said Michael Skinner, an agency trader at Wall Street Access. "We walked into some pretty good widening in the morning after stock markets got hit in Europe and Asia. Agencies were certainly wider against Treasuries but kind of outperformed swaps."

The Dow Jones Industrial Average fell below 10,000 during intraday trading Tuesday, sparking widespread concern throughout the markets. Like all other spread products, agencies took a hit, moving out as much as 3 to 4 bps during the day, Skinner said.

But the stock markets staged a late rally, with the Dow moving just above 10,000 just before the markets closed, and that tide carried credit markets with it.

"Swaps came in, agencies came back in, and there was momentarily peace in the world, although it was only for an hour or so," Skinner said.

Trading volumes were "not bad," he added.

Callable issuance was brisk, with issuers exploiting the volatility.

"What has been the case with spikes like this is it makes callables cheaper to originate, so we have seen some origination in callable land, and some accounts have taken advantage of this," Skinner said.

Skittish investors

The market's volatility on Tuesday was fuelled by growing concerns about the brewing conflict between North Korea and South Korea, another agency trader said. Those fears compounded existing worries about the debt crisis in Europe, and investors were quick to run toward safer instruments like Treasuries.

"First it was our domestic economy; then it was Europe; now it's Korea," the trader said. "It never ends. I think there's a segment of the market that's just sitting there and biting their nails, and it doesn't take a lot to set them panicking...there's no way we can keep up with Treasuries in this kind of an environment."

The trader thought that the volatility could continue for quite a while.

"The only thing that's going to get this market functioning rationally again is if we get greater confidence out of Europe," the trader said. "Korea's kind of a wild card right now, so I won't say too much about that. If we can get some calm into the market and yields go back up, we'll see better flows."

Freddie Mac ahead

Freddie Mac could announce a two- or three-year offering of Reference Notes on Wednesday in its second May calendar opening, the traders said. The agency skipped its first calendar slot on May 5.

"My guess is Freddie Mac is going to come out with a two-year," Skinner said. "It seems to make the most sense...Three-years is also possible. It's definitely going to be front-end, [but it] won't be further out than that."

The other trader agreed that a front-end deal is most likely.

"I think two-years are the most likely because of funding levels right now," the trader said. "And Freddie Mac hasn't done a two-year since November. There's demand for two-years."

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