Agencies narrow ahead of euro-zone meeting on Greece; FHLB's new two-year notes sell well

By Kenneth Lim

Boston, July 20 - Agency spreads narrowed a touch in the front end on Wednesday ahead of a possible relief in Greece's debt crisis, while Federal Home Loan Banks drew strong demand for an offering of two-year notes.

Bullet spreads closed the day about 1 basis point tighter versus Treasuries in the two- to five-year sectors, while longer maturities slipped slightly.

"We're seeing a lot of stuff go across in the regions and with callables," an agency trader said.

Trading in bullets was muted, however, because of uncertainty surrounding the debt ceiling.

"Despite the fact that the screens are well populated right now, some of it is choppy deal-related flows," the trader said. "There's no really strong bias for buying or selling right now."

The typical summer lull is also affecting volumes.

"It is the middle of July and a lot of people are out," the trader said. "I think a lot of stuff got done last week, and earlier this week has been somewhat subdued."

But the callable market saw brisk activity in short-term issues.

"There was a bunch of billion-dollar one-year issues that have been coming off-market," the trader said. "And interest in institutions continues to be in two- to three-year paper. It seems like a lot of smaller step deals are getting printed from regional dealers."

FHLB sells two-years

Despite ongoing concern about a potential downgrade of agency paper amid the ongoing battle over raising the debt ceiling, FHLB had little problem selling $3 billion of new two-year Global Notes on Wednesday.

The 0.5% notes priced at a spread of 20 bps over Treasuries and went out the day at spreads of about 19 bps bid, 18.5 bps offered, the trader said.

The notes sold at 99.861 to yield 0.567%. Price talk was at a spread of 21 bps over Treasuries.

BNP Paribas Securities Corp., Citigroup Global Markets Inc. and Credit Suisse Securities (USA) LLC were the lead managers.

The deal drew strong interest during marketing, and the order book was probably close to $5 billion, the trader added.

"But the deal wasn't going to grow, and it was well received," the trader said.

The offering eased any concerns about nervous investors shying away from new issues amid the possibility of a downgrade if a deficit deal is not achieved in Washington.

"The GSEs have been forced to send out to everyone about [Standard & Poors] and Moody's talking about the downgrade possibility...but having said that, Home Loans went without a hitch, and Fannie Mae [a week ago] went without a hitch," the trader said.

Europe, debt crisis eyed

But the market has not been able to move very far from current levels as uncertainty about Europe and the debt ceiling hinder trading.

On Wednesday, some of the concerns about Europe appeared to ebb ahead of a meeting of European leaders to discuss further action on debt-stricken Greece.

The U.S. debt ceiling debate was stuck in limbo a day after a bipartisan group of six senators presented a proposal to cut the budget deficit by $3.7 trillion over the next decade. The plan was seen as a sign of progress toward a deal to raise the debt ceiling by Aug. 2, but it remains to be seen whether the plan will be approved by lawmakers.

"We're a little paralyzed right now," the trader said. "We're kind of sitting and watching...The market's really been trading as though nothing's going to change, but the fact of the matter is there's just enough caution, especially in some of the money fund types."

Agency spreads will probably come in if a good enough plan emerges from Congress. But beyond getting the debt ceiling raised, Washington also has to have a credible deficit-reduction plan in order to appease investors and the ratings agencies, the trader added.

"The thing you've got to remember is even if they agree to raise the debt ceiling, the ratings agencies have stated that unless they include a concrete deficit reduction plan along with the debt ceiling raise, they're still subject to downgrades," the trader said.

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