Agencies mixed as market treads water amid respite in Europe; Freddie Mac offering eyed

By Kenneth Lim

Boston, Sept. 13 - Agency spreads closed mixed Tuesday as the market remained illiquid and Treasury yields rose on a lull in negative European debt news.

The two-year bullet spreads closed the day mostly unchanged. The three-year spread was about half a basis point narrower after taking into account the roll. The five-year spread was also 0.5 bp tighter versus Treasuries, while longer maturities ended flat.

"There was a little nervousness at the start of the day on the news in Europe going back and forth," said Craig Ziegler, an agency trader at Gleacher & Co.

Callable volumes remained relatively active, driven by the high rate of redemptions in the current low interest rate environment.

The largest deal seen on Tuesday was a two-year non-callable six years, while negotiated deals dominated the step-up scene.

There's "still a huge amount of bonds being called, and a huge amount that needs to be reinvested, particularly in five-years and under," Ziegler said.

Yields nudge higher

Yield levels rose slightly Tuesday as investors continued to retreat from record-high prices on a quiet news day on the European debt crisis front.

"The European uncertainty has created a bit of a questionable feel for accounts right now," Ziegler said.

European leaders on Tuesday sought to contain fears that Greece would be forced to default as borrowing costs skyrocket for the debt-laden country.

German chancellor Angela Merkel said Tuesday that avoiding an "uncontrolled default" of Greece was a top priority. Merkel, French president Nicolas Sarkozy and Greek prime minister George A. Papandreou were scheduled to meet via video conference on Wednesday to discuss the issue.

U.S. president Barack Obama also called on European leaders to take coordinated action on the crisis, while U.S. Treasury secretary Timothy Geithner will meet European finance ministers in Poland on Friday.

Those actions appeared to pause the flight to dollar-denominated safe havens that have characterized the past week, but investors have yet to reverse course.

"There's an effort at sending out a consistent message to the market that they're taking this very seriously and doing all they can," the trader said. "But unless we see some concrete action that's effective, the market's not going to retrace its steps. We're just treading water here while we wait for the next step."

Freddie Mac ahead

Freddie Mac was expected to announce an offering of new Reference Notes on Wednesday.

"Most people are leaning toward a two-year, and possibly a five-year," Ziegler said.

Although issuing three-year notes is cheap and demand is healthy in that sector, Freddie Mac last issued a three-year deal in June and may not have strong funding needs in that sector right now, he added.

"I think the market could handle a new three-year issue...but they haven't come to market with a two-year benchmark in some time," Ziegler said.

The uncertainty over Europe and anticipation of a supply announcement by Freddie Mac kept trading volumes muted on Tuesday.

"There's not a lot going on, unfortunately," Ziegler said. "Freddie Mac's on the calendar tomorrow, so we're waiting on that."

Ziegler expects a Freddie Mac deal, if there is one, to go well because demand is strong at the front end of the curve.

"As the market is showing, there's great appetite for front paper," he said.

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