Agencies flat as yields drop on Portugal downgrade; Freddie seen skipping Reference Notes

By Kenneth Lim

Boston, July 5 - Agency spreads closed unchanged on a quiet Tuesday as yields slipped on renewed concerns about the situation in Europe; the callable market saw decent demand.

Bullet spreads ended the day unchanged versus rallying Treasuries as Moody's Investors Service cut Portugal's sovereign credit rating to junk. But agencies outperformed swaps, which lagged Treasuries.

Trading of bullets was slow with the market still sluggish after a three-day weekend.

"I'm afraid I don't really have much to say about today," one trader said. "I would just call spreads unchanged. Low volumes, not a lot of stuff going on."

But the callable market was a little more active on demand related to the start of the quarter.

"A lot of people just got done with the quarter end and they just needed to replace their balance sheets with the first day back," the trader said.

A handful of new deals printed in the callable arena, although dealers were the main driving force behind the demand.

"Some issues were done, but not a tremendous amount of inventory demand on the day," the trader said. "It was more of dealers taking inventory on their balance sheets."

Yields fall back

Absolute yield levels came back down on Tuesday following Moody's decision to cut Portugal's debt rating by four notches to Ba2.

"The Moody's downgrade reminded the market that the Europe problem hasn't gone away yet," another market source said.

Investors were not completely taken by surprise when the downgrade was announced, given that Portugal's debt problems are well known and the country's credit rating has already been cut. But a downgrade could make it harder for Portugal to stave off default.

"It's not unexpected, but it doesn't help in any case," the source said. "It made the market trim last week's optimism about Greece to maybe more realistic levels."

The market could hold off on selling Treasuries until the Greece situation becomes a little clearer.

"It's very important that they get it right on Greece," the source said.

Freddie Mac ahead

The market was not expecting any supply out of Freddie Mac, which will give a calendar announcement on Reference Notes issuance Wednesday.

"I kind of expected that they would pass on one of their two announcements this month, so I'm not expecting anything in the next one," the trader said.

Freddie Mac on June 30 priced $5 billion of new three-year notes, reducing expectations that it will tap the market again just a week later.

If the agency passes, its next calendar opening will be on Aug. 2.

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