Agency spreads narrow but lag as swaps tighten; FHLB could announce two-years, trader says

By Kenneth Lim

Boston, June 15 - Agency spreads edged narrower at the front end of the yield curve on Tuesday as investors moved out on the risk spectrum amid an uptick in confidence about Europe.

But the agency market may have been a little more conservative about buying with supply from Federal Home Loan Banks expected to be announced on Wednesday.

Bullet spreads closed about 1 basis point tighter versus Treasuries on the short end of the curve on Tuesday as Treasury yields rose and swap spreads came in. Treasury prices fell as Spain, Belgium and Ireland successfully sold debt amid concerns about the credit stability of Europe.

"Swaps are in 1.5 bps, so it's trailing swaps slightly," an agency trader said. "The rest of the curve is roughly unchanged."

Despite the tightening, the market seemed to lack strong bids. The richness of the market could have been a factor, but summer distractions may also have played a part, the trader added.

"I haven't really seen a whole lot of buying in the first place," the trader said. "There's a little bit of a lack of commitment. Maybe it's the World Cup."

Trading volumes were slow, but still an improvement over a whisper-quiet Monday.

"In bullet land we've been a little quiet," the trader said.

Callables see slowdown

Callable action saw good two-way flow on Tuesday, although volumes were slim and remained dominated by step-up structures, the trader said.

The low volumes are partly due to the richening of callables against bullets.

"A lot of these callables are so tight where you can do bullets instead," the trader said. "It's hard to compete."

Federal Farm Credit Banks has been a busy issuer of callables, "crushing the market with a bunch of supply all across the curve," the trader said. Fannie Mae on Monday also pushed out a deal that was priced "real cheap," the trader added.

Auctioned deals currently offer better terms for investors than negotiated offerings, the trader said.

"These auction deals are coming at more favorable levels, closer to Libor minus 15 to 25 bps range, so people are jumping on that stuff," the trader said.

FHLB two-year expected

FHLB could announce an offering of two-year Global Notes when it makes a calendar announcement on Wednesday, the trader said.

Market expectations of a front-end offering could have kept that part of the curve from tightening further on Tuesday.

"I'm not sure why [the market did not tighten further] on Tuesday, but with the supply coming from Home Loans, we're expecting a two-year, so that could be one reason," the trader said.

FHLB has not issued new two-year Global Notes since March, so the agency could be looking to fund in that part of the curve again, the trader explained. Funding levels are also attractive in that sector.

"I think it's sub-Libor minus 19 bps or so," the trader said. "Three-year is Libor minus 10 bps, so a two- or three-year [is possible,] probably a two-year because of the extra funding."

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