Agencies mark time as volatility, valuations deter bids; small Fannie Mae deal seen, if any

By Kenneth Lim

Boston, March 24 - Agency spreads held for another session on Wednesday as investors continued to hug the sidelines amid rich valuations and uncertainty in the markets.

Bullet spreads closed flat on the day, with little in the way of news to spur bids one way or the other.

"Spreads are pretty much unchanged," said Michael Skinner, an agency trader at Wall Street Access.

Callable activity was mixed.

"Callable issuance has been spotty," Skinner said. "Some stuff has worked, some stuff hasn't."

Following a rash of redemptions in the previous week, the market is flush with cash that could be reinvested in new callables, but investors are still holding out and hoping for a sizable jump in coupon levels before buying back in.

"Everyone's waiting for a back-up in rates," Skinner said. "But it hasn't happened. Although a lot of people say they have a lot of powder and they want to use it."

Low volumes

Volumes continued to struggle on Wednesday as uncertainty about the domestic economy and brewing centers of concern in Libya, Japan and Europe combined to create extremely volatile markets.

But the agency market has not helped itself by being historically rich, both in terms of absolute yields as well as spreads. An expensive market can price out some investors and discourage bids, and also reduce the market's sensitivity to changes in absolute yield levels. The result is that trading activity slows down.

"Not only are the absolute Treasury levels rich, spreads are tighter than they used to be," Skinner said.

Fannie Mae ahead

Investors are not setting their hopes high for supply this week with Fannie Mae slated to make an issuance announcement on Thursday.

"I don't think they have huge needs," Skinner said. "I could see a two- or five-year reopening or maybe even a pass. When they did the five-year last month, they had really big demand, so they could potentially reopen that one."

Libor valuations have also tightened in the five-year sector, so the agency would have some incentive to reissue in the five-year sector. But the key factor will be where Fannie Mae's funding needs lie, Skinner stressed.

"I just don't know what their needs are," he said.

A lack of supply would only be supportive of tight spreads.

"If we don't get supply, there's really no reason to go out," Skinner said. "So we could see agencies grind tighter. People still need Aaa products, so it's positive for spreads."

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