Agencies widen as market lags surging Treasuries; FHLB skips issuance amid supply drought

By Kenneth Lim

Boston, Aug. 11 - Agency spreads eased out slightly on Wednesday as the market struggled to keep up with rallying Treasuries.

"Agencies are a little wider," an agency trader said. "It seems like we're under some pressure, but we saw some very good buying today."

Callables did better, with issuance coming at a brisk pace as issuers continued to call old notes, fueling reinvestment interest in the market.

"We keep selling them, and they're hard to keep on the books," the trader said. "New issue coupons just get lower and lower. It's hard to replace them, and investors keep reaching for them as they reach for yield."

A market source said trading volumes were better than average for the summer.

"There's pretty good interest in the market right now, especially after the Fed's announcement yesterday," the source said. "A lot of buy interest. We'd be trading more if there was more supply and more sellers."

FHLB skips issuance

Federal Home Loan Banks said Wednesday that it will not issue any Global Notes this week.

The agency's issuance calendar reopens Sept. 14.

The news seemed to catch the market by surprise, with many expecting the agency to come with a deal at the front end of the yield curve.

"I was very surprised by that," the trader said. "But I think they'll be back in September. I think that the funding levels for three-years were pretty good. They were better than they've been for some other issuers this year."

Skipping the issuance suggests that FHLB's funding needs are not "that much," the trader said. The agency needs cash, but at the moment it appears to be able to get it more easily elsewhere.

"I think it shows they can get better funding through callables and [medium-term notes]," the trader said.

The market source said front end spreads may have come in slightly because of FHLB's decision.

"I think the market's disappointed that the supply didn't materialize," the source said. "Spreads in two- and three-years may have tightened a little. A lot of people were hoping to pick up some cheap paper through the new issue because they're not getting a lot of yield from the secondary market. And if there's no supply, nobody wants to sell."

Supply, Fed buying guide market

The trader said the market is not at historically tight levels yet, but the lack of supply in the market could keep spreads narrow for a while.

"We're a long way off the tights in some respects," the trader said. "Some of the five-years, seven-years...and three-years got beaten up a bit. But new issuance has also dried up, so from a supply standpoint I think the technicals are favorable."

The Fed's decision this week to restart its buying of two- to 10-year Treasury notes could be a mixed blessing for agencies.

"If we go to lower yields, I think it's conceivable that we could continue to see spreads tighten," the trader said.

But the source said some buyers could keep away because yields are too low.

"If spreads remain tight and yields continue to be at record lows, I don't know if too many people will be interested in buying bullets," the source said.

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