Agencies narrow as yields attract conflicted investors; FHLB could sell notes in front end

By Kenneth Lim

Boston, June 14 - Agency spreads tightened slightly on Monday as investors sought higher yields amid an early improvement in risk appetites.

Bullet spreads closed 1 to 2 basis points narrower versus Treasuries across the yield curve, said Ted Ake, managing director of U.S. Treasury and agency trading at Societe Generale.

"Spreads came in 1 to 2 bps along the curve, which is a reflection of the fact that people are still looking for some kind of return on their money," he said. "Those are people who don't want to buy Treasuries because there's no yield in Treasuries."

Another agency trader said trading volumes were nevertheless weak.

"One, it's the summer, which means Mondays and Fridays are even slower than usual," the trader said. "Two, I think there's still a bit of uncertainty in the market that's keeping a lot of money away."

Conflicting signs

Monday's tightening happened early in the day, as reports of higher industrial production in Europe eased fears about the health of the continent's economies.

"Obviously people thought that it was good news," the trader said. "The European markets improved; the euro strengthened; we went along for the ride."

But the positive news was short-lived, as things quickly soured on Moody's Investors Service's decision on Monday to downgrade Greece's government bond ratings by four rungs, to Ba1 from to A3, into junk status. Still, agencies held up as some of the flight-to-quality trades came to agencies instead of lower-yielding Treasuries, the trader said.

The downgrade was surprising in its timing, if not in its substance.

"I don't think anybody should be surprised that Greece debt is now junk," the trader said. "You know what they say; the ratings usually come after the market's made up its mind."

But the opposing signals continue to deprive the market of what it needs most at the moment - a clear direction, the trader added.

"The worst thing we can have is being stuck in this range," the trader said. "Because, one, nobody knows how long it's going to last, and two, nobody knows where we're emerging from when we do get out of the range."

FHLB on the radar

Federal Home Loan Banks could announce an offering at the short end of the curve on Wednesday, the trader said.

"Two- or three-years," the trader said. "Five is a long shot, I think."

The trader expects the agency to come with a small deal or a reopening, given that demand is not as strong right now after Fannie Mae flooded the market with $9 billion of paper over the previous two weeks.

"If they don't have great funding needs, which they don't, I don't expect them to raise too much," the trader said.

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