Agencies firm as escalation in Japanese crisis lifts Treasuries; FHLB expected to pass

By Kenneth Lim

Boston, April 12 - Agency spreads held firm on Tuesday in the face of a Treasury rally, but volumes remained extremely light.

Bullet spreads closed the day flat, an agency trader said.

"Spreads are kind of unchanged," the trader said. "Nobody's doing anything."

The callable market saw decent demand on the back of the recent gains in yields.

"We have done a few new issue callables that have all gone OK," the trader said.

Treasuries climb

The fact that agency spreads did not widen much was a sign of strong demand in the market, another trader said.

Treasury yields fell on Tuesday following Japan's decision to escalate the severity rating of the nuclear disaster in Fukushima. The Japanese government on Tuesday raised the severity rating to a worst possible 7, from 5, putting the disaster's rating on par with Chernobyl.

The change sparked flight-to-quality bids that pushed Treasury yields lower, the second trader said.

"The issue was kind of pushed to the back of people's minds for the past couple of weeks," the trader said. "The news was a bit of a surprise and people took some risk off their portfolios."

The trader said the raising of the severity rating may actually limit the future effect of the nuclear disaster on yield levels.

"If this is the worst possible level they can get, then in a way it can't get that much worse," the trader said. "You're kind of pricing in a full-scale disaster, right?"

Agencies had a decent outing despite the higher Treasury yields because investors are reluctant to sell.

"It's hard to find sellers when the outlook for spreads is so positive," the trader said, explaining that investors are expecting supply to tighten as Fannie Mae and Freddie Mac try to trim their portfolios.

FHLB ahead

The market was not seen setting up for potential supply from Federal Home Loan Banks, which has a calendar announcement on Wednesday. The general consensus is that the agency could pass on the issuance window.

"I'm not hearing much, other than that they might pass," the first trader said. "Everything I'm hearing is they'll probably pass; if not, they'll come with a two- or three-year."

The rest of the week could remain quiet for agencies, which have struggled to capture much interest from investors amid historically low yields and tight spreads.

That could change if the market cheapens slightly, the trader said.

"I think it's pretty likely that we'll start to see buyers above 3.60% on 10s," the trader said.

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