Agencies widen with swaps as warning on Italian banks adds to Europe fears; supply looms

By Kenneth Lim

Boston, June 24 - Agency spreads moved out on Friday amid more risk shedding following warnings of possible credit rating downgrades for Italian banks.

Bullet spreads shifted out by 1 basis point to 2 bps across the yield curve, moving in sympathy with swaps against Treasuries.

"Agencies got caught in another flight to quality," an agency trader said. "Swaps were out, spreads were out across the board on the Moody's news. But it wasn't as bad as last week's announcement on the French banks."

Trading volumes were thin partly because the high market volatility kept some money on the sidelines and partly because of the coming weekend.

"Choppy day and spreads and yields going everywhere, but [there were] not a lot of flows," the trader said.

Callables, meanwhile, continue to draw strong interest because of the relative cheapening of agency spreads.

"Callables are moving fast," the trader said.

Swaps widen out

Agencies struggled to keep up with Treasuries in the face of the flight to quality after Moody's Investors Service warned that the credit ratings of Italian banks were at risk of downgrades.

The credit ratings agency on Thursday said 18 Italian banks could see their ratings cut if Moody's downgrades Italy's sovereign debt. The move comes shortly after Moody's also warned of a downgrade on Italian debt.

"It's not unexpected because of the review on the sovereign debt, but it's one more piece of bad news on the growing pile of bad news about Europe," the trader said.

The concerns about the debt crisis in peripheral European economies led swap spreads to widen across the board, with the two-year swap spread out by about 3.25 bps, the trader said.

Treasuries, meanwhile, saw yields fall again as investors sought safe havens away from Europe to tide over the weekend.

"Agencies were dragged down with swaps," the trader said.

Supply ahead

The week ahead is unlikely to bring much tightening pressure for agency spreads despite $99 billion of Treasury auctions in the pipeline.

The Treasury will sell $35 billion of two-year notes, $35 billion of five-year notes and $29 billion of seven-year notes Monday through Wednesday.

"I don't foresee any really weak auctions as long as Europe continues to hang around on the edge," the trader said. "Unless we get some big positive news on Greece over the weekend or some really good economic news, those auctions are going to move really easily."

Agencies could see some supply from Freddie Mac on Wednesday, which would put pressure on agency spreads.

"They could do something in the front end," the trader said. "It's very attractive now for them."

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