Agency spreads widen as rates up on easing of Libya, Japan fears; market shrugs off MBS sale

By Kenneth Lim

Boston, March 21 - Agency spreads eased out slightly on a light Monday, mostly recovering from an early scare after the Treasury Department announced plans to wind down its portfolio of agency mortgage-backed securities.

Bullet spreads closed a touch wider on the day, but did not venture away from recent levels.

"Spreads were trading within a tight range," an agency trader said. "We had widened out a little bit, but really it's just a rate trade now."

The agency market is showing signs of being a rates market rather than a spread market, where price and yield movements are more in line with how Treasuries are performing, the trader added.

"Spreads are so tight, there's not much room for spreads to move one way or another, so they're pretty much trading on rates, sellers when rates drop and buyers when rates go up."

Monday's move reflected that aspect of the market, with agencies not moving by much as Treasury yields fell.

A coalition of countries, including the United States, France and Britain, began strikes into Libya over the weekend, giving some investors hope that the attack would prevent the situation in the Arab country to degenerate further. Japan also reported slight progress in efforts to contain a nuclear crisis in its earthquake-hit regions.

The flight-to-quality bids also let up as the stock market gained on Monday, buoyed by merger-and-acquisition headlines.

Forced outwards

Callables had a relatively quiet session amid continued wariness about the fighting in Libya and post-earthquake Japan.

"We had a little uptick on Thursday and Friday in volatility, which obviously is beneficial to issuers, but it tends to widen callable spreads a little bit," the trader said. "Things quieted down a little bit today with the stuff in Japan and Libya, so net-net we tightened in callables."

The trader noted a recent increase in callable redemptions, which raises the possibility of increased issuance over the coming week on any jumps in coupon rates.

"Basically we hadn't seen interest in a while, and suddenly in the last 10 days, we saw an uptick in call redemptions," the trader said.

But investors may have to take on more risk when they reinvest their money, the trader said.

"Investors seem to be pushed out on the maturity curve or down the credit curve," the trader said. "I had one client with a two-year securities getting called [...] and now he has to move out three months to get the same yield."

MBS not a factor

The market had a short-lived kneejerk selloff early on Monday after the Treasury Department said it would begin to wind down its $142 billion portfolio of agency mortgage-backed securities by selling about $10 billion a month. Those securities were acquired in 2008 and 2009 during the height of the financial crisis.

"Initially spreads widened, then people kind of looked closer and determined there was no net effect on agencies," the trader said.

The week ahead will probably continue to be dominated by the events in Libya and in Japan, the trader said. Fannie Mae has a calendar announcement on Thursday and could pass "given the lack of funding needs," the trader said.

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