Agencies widen on drop in home sales, flight to quality; Fannie Mae supply seen limited

By Kenneth Lim

Boston, Aug. 24 - Agency spreads grew on Tuesday as the market continued to seek out safer assets amid another drop in monthly reported U.S. home sales.

"Agencies were a tad wider today, mostly carrying over from yesterday," said Joseph J. Riley, senior managing director of institutional sales and trading at Mesirow Financial.

Trading volumes were decent, with a balanced flow of buyers and sellers, Riley added.

"There was good two-way flow," he said. "A lot of extension trades for two-years and into five- and seven-years. [There was] not so much in the longer end, but we did get some nice trades done in zero-coupon paper, Fannie Mae and Freddie Mac strips."

Another trader said callable issuance saw decent volumes, although printing of new paper was slower than the week before.

"Investors are still interested in callables, especially step-ups, but callables are very expensive at the moment," the trader said. "If you're willing to buy a callable, in some cases you can get better value in bullets or in corporates."

Economic fears

Another trader said bullet spreads widened by about 1.5 basis points to 2.5 bps across the yield curve on Tuesday as investors continued to buy into Treasuries.

"Swaps did pretty well in the morning, but agencies underperformed today," the trader said. "And Treasuries did well too; so, relatively speaking agencies didn't do so well today."

Spreads came under a little bit of pressure after July sales of previously occupied homes fell to 3.83 million, according to the National Association of Realtors. The Street had been expecting sales of about 4.7 million.

The weak data sparked a flight to quality among investors, and agencies could not keep up with surging Treasuries, the trader said.

"We can only watch and wait for the spillovers," the trader said.

The trader cautioned against being too pessimistic about agencies, however.

"If you look at absolute yields, agencies are still doing pretty well," the trader said. "If you compare them to Treasuries, of course you'll see that spreads are wider. But everything is falling behind Treasuries these days."

Low hopes for supply

The trader said Fannie Mae's calendar announcement on Benchmark Notes on Thursday is not expected to make much of a dent in spreads.

"I think they're going to pass or reopen," the trader said.

With the current low rates and historically tight spreads, Fannie Mae would be getting funding at a relatively low cost if it issues new notes, the trader said. But the agency does not have huge pressing needs for funding, and the market may feel that current levels are too rich.

"Freddie Mac came with a three-year last week, and I thought it didn't go that well because the market just wasn't comfortable with the pricing," the trader said. "There's more demand farther out the curve where yields are higher, but the front end is kind of hitting a valuations wall."

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