Agencies mostly flat as tightening keeps spreads compressed; callable volumes slow down

By Kenneth Lim

Boston, Feb. 17 - Agency spreads closed flattish on Thursday as recent tightening helped to rein in volatility despite swings in the Treasury market.

Front-end bullet spreads underperformed slightly, while longer maturities came in versus Treasuries, an agency trader said.

Spreads were "pretty much unchanged," the trader said, noting they were "slightly tighter in the longer end, slightly wider in the front."

Federal Home Loan Banks' new 1% two-year Global Notes, which priced Wednesday at a spread of 16.5 basis points over Treasuries, ended Thursday at spreads around 17.5 bps bid, 17 bps offered.

Callable issuance languid

Callable issuance remained muted with Thursday's drop in coupon levels, but secondary trading was active.

"We are seeing a lot of flow," the trader said. "The activity is pretty good. With the market rallying like today, that puts a lot of people off, and the market has to adjust to what the new levels are. Coupons don't look as appealing."

The lower Treasury yields help existing positions, but new issue volumes take a hit because the new coupons do not look as attractive, the trader explained.

"When we're in a bear market and whatnot, most guys are going to be hedging on their positions, and it's tough to trade that market," the trader said. "If we continue to rally here in Treasury space, I think it's going to be difficult to underwrite callables."

Ultimately, the callable market wants to see some calm in the markets.

"What I'm saying is, you need some stability in rates," the trader said.

Spreads remain resilient

Agency spreads have not budged significantly in the face of up-and-down Treasury yields over the past week in the wake of the Obama administration's proposal for the future of Fannie Mae and Freddie Mac, the trader said.

"Because of the Treasury announcement, you had sort of a reaffirmation of their credit, so along those lines, you had spreads tighten in a lot, and when spreads are so tight, and there's so much spread compression, it reduces the volatility of spreads."

On Feb. 11, the Treasury Department and the Department of Housing and Urban Development delivered a paper to Congress outlining the White House's plan to wind down Fannie Mae and Freddie Mac. The paper also offered three options for a post-Fannie Mae and Freddie Mac system of housing finance.

The paper also stressed that the government is committed to ensuring that the two government-sponsored enterprises will have enough capital to meet all debt obligations.

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