Agencies spreads narrow with swaps, smaller-than-expected Global Notes issuance from FHLB

By Kenneth Lim

Boston, July 20 - Agency spreads tightened on Tuesday in line with swaps and yet another disappointingly small bullet issuance.

Bullet spreads closed about 1.5 to 2 basis points narrower versus Treasuries across the yield curve, an agency trader said. Agencies also reflected tightening of swap spreads as investors poured into the fixed income market amid weakness in stocks.

"We saw trades up a decent amount today," the trader said. "The Treasury market was doing better, and they still tightened."

Trading volumes were "fairly heavy," the trader said, and callable issuance even more so.

"Callables are tightening more than bullets because there's a direct correlation there to the bond market, because there's an optionality in the callables," the trader said.

FHLB reopens three-years

Federal Home Loan Banks sold $1.25 billion of a reopened series of 1.875% three-year Global Notes on Tuesday to yield 1.03%.

The notes were sold at 102.421 through an auction.

There is now $4.25 billion of the notes outstanding.

The offering disappointed the market, which had been hoping for new paper in an offering of at least $3 billion.

"I was a little surprised that they didn't just do a bigger issue and take advantage of [low] yields," the trader said.

The FHLB reopening is the second one in a row in the primary bullet calendar, coming after Freddie Mac's reopened series of five-year notes for $1 billion a week ago.

"There are a lot of redemptions and not a lot of funding needs," the trader said.

Supply sucks spreads in

The slow pace of issuance is one of the biggest drivers of the current tightness in the agency market, the trader said.

"It's negative supply," the trader said. "There's supply coming, but you have the fact that there was like $74 billion called last week, and nothing near that amount issued. And there's more cash entering into the system because of the calls."

Investors find themselves in unusual territory. The market has seen such tightness before, but not at such low yield levels, the trader said. And where the market would usually put up a resistance against tighter spreads, this time investors seem unrelenting in their pursuit of agencies.

"You would think that you'd be seeing a lot of resistance, but you're not really seeing a whole lot of it," the trader said. "I started thinking about a correction. Given the scenario that's going on, what is going to widen spreads? And the only thing is if we're going to see any signs of the economy improving, and I don't see that happening soon."

The trader, who expects spreads to remain tight for the next six to nine months, added that the lack of supply is playing a bigger role in spread levels at the moment than the economy.

"If the agencies themselves don't need a lot of cash, but the market wants agency paper...they can dictate the terms of the market, and that's just going to compress spreads," the trader said.

Such tightness in the market has not been healthy. Volumes have been decent, but the level of interest in the market is taking a hit.

"There's not a lot of creativity, not a whole lot you can do," the trader said.

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