Agency spreads pause from tightening; foreign participation in FHLB deal unusual: analyst

By Kenneth Lim

Boston, April 8 - Agency spreads closed flat on Thursday, with the longer end of the yield curve underperforming a tad as the market paused from recent tightening.

Bullet spreads ended unchanged to slightly narrower at the front part of the curve, while spreads further out saw a little bit of widening.

"Most of the size trades we've been doing here have been in the two- to three-year area," said Joseph Riley, senior managing director of institutional sales and trading at Mesirow Financial. "I understand the long end isn't doing as well. The longer end was 0.5 to 1 basis point wider than this morning."

The newly minted Federal Home Loan Banks 1.875% Global Notes due June 2013 also ended unchanged at a bid spread of 24 bps and an offer spread of 23.5 bps. The notes priced at an initial spread of 23.5 bps on Wednesday.

Step-up issuance continued to be strong as investors favor the defensive structures.

"The group here that does new issuance...every deal that they have brought has been step-ups," Riley said. "Clearly the client base has an appetite for step-up paper right now. Step-ups are a lot more defensive than straight callable paper."

Rates capture attention

The market has recently been led by swaps and the Treasury market's ups and downs, Riley said.

"The last couple of days were kind of crazy," he said. "The Home Loans deal was originally at 32 bps, then it became 30 bps, and when they priced it, it came at 23.5 bps. We had an outstanding 10-year [Treasury] auction, and you saw what happened to rates, and today the 30-years went fairly well."

An agency analyst said the agency market is getting "the same sort of buying interest that Treasuries get for the most part because of all the backing that they've got now."

"I think generally speaking people expect to see higher rates at some point, but there's this whole background of flight to quality going on," the analyst added. "You can see that when Greece has problems, rates go up."

Rich market

Agency spreads had widened in past weeks, and this week's tightening essentially brought valuations back to previous levels, the analyst said. But those previous levels are extremely rich, and fund managers are reluctant to buy up more agency debt at the moment, the analyst said.

"The whole curve is just stinking tight," the analyst said. "One might argue it's cheap versus Libor, but nobody I know buys a bond based on Libor anymore."

But FHLB's offering on Wednesday, which saw central banks take 46% of the notes offered, raised the possibility of renewed foreign demand for the market. Foreign central banks' participation in benchmark deals is usually around the 20% region, the analyst said.

"The international flows are not very positive for agencies in general," the analyst said. "But if something changes and they buy more and more over time, my sense is it could be a big force, whether the international economy comes back to agencies. This three-year is a single data point, but it's an interesting data point."

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