Agencies tighten slightly as supply pushes Treasury yields higher; Freddie could skip sale

By Kenneth Lim

Boston, Feb. 23 - Agency spreads narrowed a touch Wednesday as Treasury yields rose on supply pressure, while volumes continued to struggle.

Bullet spreads came in slightly versus Treasuries, an agency trader said.

"Another fairly quiet day," the trader said. "Spreads all in all tightened somewhat, coupled with swap spreads moving in and simply supply issues that continue to lurk out there."

The front end of the yield curve performed slightly better.

"Anything in the front end, four years and shorter, are doing better and there seems to be demand for," the trader said. "Out past five years is slowing down somewhat. Everybody's not so sure about the market, especially with what's going on with the Middle East."

Callable activity was also muted, although step-up products continue to see healthy interest.

"Just because they're perceived as a defensive move to protect against rates rising," the trader said.

The yield curve remains very steep, so investors do not have to venture very far out into longer maturities to pick up a good improvement in returns.

"The curve is very, very steep, so investors are staying short," the trader said. "The difference between three-years and two-years right now is 50 basis points, which is amazing."

Treasuries fall

Treasury yields climbed on Wednesday on the back of a weak auction of five-year Treasury notes and ahead of a seven-year auction on Thursday.

The volatility in rates has been keeping a lid on trading volumes in agencies as investors grapple with the fickle market.

"It's shaping up to be a quiet week because we're trading off of so many unknowns," the trader said. "We had a slow start to the week anyway. You started to see people taking more of a cautious stance."

The current unrest in the Middle East is complicating the outlook for the market, the trader added. In the short term, the unrest has sparked some flight-to-quality trading. In the longer term, investors are concerned that the unrest could push oil prices higher and affect the economy.

"The first six weeks of the year you had people saying that the economy was 'doing better,' and now with what's going on with the Middle East you seem to have reversed instantly," the trader said.

Freddie Mac ahead

The agency market is now reliant on new issues to spark activity, but traders may not get much relief from Freddie Mac on Thursday, the trader said.

The agency has a calendar announcement on the issuance of Reference Notes slated for Thursday, and could simply pass on the slot even though the market has richened for investors, the trader said.

"I'm not hearing anything...They're trying to shrink their portfolios, and the amount of call occurrences slowed dramatically with the move we had in the last few days," the trader said.

Freddie Mac has very little need to raise capital at this time, with the housing market still shrinking and loan demand down. The agency may want to raise money if it anticipates calling a lot of debt, but Freddie Mac also wants to cut down the size of its portfolio.

"If rates stay down here a bit longer, maybe they'll want to do something just for the roll," the trader said.

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