Agencies nudge tighter as Moody's maintains GSE ratings; ISM data disappoints market

By Kenneth Lim

Boston, Aug. 3 - Agency spreads narrowed slightly on Wednesday as the market benefited from an affirmation of credit ratings and a modest flight to quality amid weak economic data.

Bullet spreads tightened by about half to 1 basis point versus Treasuries.

"We widened out on the concern about the economy, and it was a risk-on, risk-off trade, and we're on the risk-off trade," said Mary Ann Hurley, vice president of fixed income trading at D.A. Davidson & Co. "It's not a major amount, but we are still unchanged to a half tighter."

The callable market picked up as the risk of a ratings downgrade eased after Fitch Ratings and Moody's Investors Service affirmed the U.S. government's Aaa grade.

Volume "was fairly heavy today and there were a lot of new issues out," Hurley said. "I think a lot of people were buying. There's a feeling that basically the train has left the station."

Moody's affirms GSE ratings

Moody's on Tuesday affirmed the U.S. government's credit rating, and by extension also confirmed the Aaa rating for the government-sponsored enterprises.

The outlook for the ratings is negative, however. Moody's said there will be a risk of downgrade if there is a weakening of fiscal discipline, further fiscal consolidation measures are not adopted in 2013, if the global economic outlook drops significantly and if the U.S. government's funding cost rises more than expected.

Fitch Ratings has also affirmed its ratings for the U.S. government, leaving Standard & Poor's as the last of the major credit agencies that has yet to give its opinion on the debt reduction deal in Washington.

Hurley expects S&P to follow the other two agencies and maintain the U.S. rating while putting it on warning for possible downgrade.

"They've got the debt ceiling passed, but the cuts to the budget were really not quite as large as any of the agencies wanted," she said. "I'm totally not surprised that people are keeping it on credit watch negative, but I don't think they'll get a downgrade at this point."

Investors can probably put downgrade concerns aside until November, when a group of congressmen have to propose additional budget cuts.

"Even if it ends up getting downgraded, which I would not expect before year-end, Nov. 23 is the date that the newly created commission has to present their cuts, so I think if the cuts fall short, then we come back to worrying about the downgrade," Hurley said.

Economy in focus

Investors are now focused on the economy, with a string of disappointing data over the past few days casting a shadow over Friday's key labor situation report.

On Wednesday, the Institute for Supply Management's non-manufacturing index showed a drop in the index to 52.7 in July from 53.3 in June, below the Street's expectations of about 53.

The drop in activity came on the back of data that showed a drop in consumer spending, barely expanding manufacturing activity and surprisingly poor gross domestic product growth this year.

"Economic data has definitely been disappointing to the weak side," Hurley said. "And that's one of the things driving the bond market higher."

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