Agency spreads narrow after earlier parking in wider territory; Freddie Mac skips issuance

By Kenneth Lim

Boston, May 5 - Agency spreads closed mostly tighter on Wednesday despite some widening pressure earlier in the day as swaps continued to weaken.

High volatility in swaps was also seen as a possible reason that Freddie Mac decided to forgo a calendar opening to issue Reference Notes.

Bullet spreads closed the day "a touch tighter" in the three-years and longer sectors on a late tightening, having been wider for most of Wednesday, an agency trader said. Two-year paper eased about 1 basis point wider on the day, in line with looser swap spreads at the front end of the yield curve.

"Not too bad, given the volatility in swaps," the trader said. "Given the volatility in swaps earlier, we've pretty much been trading lock-step on the day."

Callable issuance was brisk in the morning as underlying volatility increased.

"Callable issuance was good early on when things were widening out," the trader said. "Freddie Mac was basically telling us that they were not adjusting their issuance models for volatility, so there were more sales from [Federal Home Loan Banks] and Fannie Mae as opposed to Freddie Mac."

Trading volumes were below average because of the rally in the Treasury market, the trader said.

"It was a pretty quiet day," the trader said. "We were busy this morning. In general we were about 75% to 80% of the 30-day moving average, so a little bit lower than usual...I think a lot of accounts have been selling this uptick here."

Volatile swaps

Much of the action earlier Wednesday was linked to sharp swings in swap spreads, which tend to be closely correlated with agencies.

Two-year swap spreads performed the worst, going out as much as 6 bps during the day, which dragged down the performance of two-year agencies, the trader said.

But agencies in general outperformed Treasuries and swaps on Wednesday.

"Given also the movement in yields to lower levels, the fact that we're pacing that counts to a pretty good day," the trader said.

Some widening should be expected down the road as swaps continue to face pressure.

"Agencies are going to have to widen in some sympathy with swaps," the trader said. "The underlying theme right now is a slow uptick in Libor...You'll see a natural widening in agencies as well, but I think for now we're going to continue to outperform."

Freddie Mac skips issuance

Freddie Mac on Wednesday said it would not use its calendar slot to issue Reference Notes. The agency's next calendar opening is on May 26.

Investors had expected Freddie Mac to issue a two- or three-year deal as late as Tuesday evening, but the sharp widening in swaps early Wednesday was a strong hint that the agency could pass, the trader said.

"When I walked in this morning, swap spreads were all over the place," the trader said. "People were looking for a new two-year, and two-year spreads at one point were about 6 bps wider on the day, and volatility was much higher.

"I think given the uncertainty in the overseas sovereign markets and the fact that they have another slot later this month that they could come in and issue, I would say it's not a surprise."

But a two-year deal by Freddie Mac would make sense at this time, the trader added.

"Given the improvement between agencies and swaps and the needs of two-years in their runs, I thought that would be a natural fit," the trader said. "But again, there was just too much volatility in the market."

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