Agency spreads widen more on profit taking; FHLB two-year notes widen on $1.25 billion add on

By Kenneth Lim

Boston, Aug. 19 - Agency spreads expanded further on Wednesday as investors continued to take profit from previous weeks' tightening, while Federal Home Loan Banks issued more notes in the two-year sector.

Spreads were 1 to 2 basis points wider across the yield curve on Wednesday, an agency trader said.

"It's been a little weak the past couple of days," the trader said. "I think the overall scene has been there's been a general resistance to rates here. We've seen better selling in our product, a slight flight to quality in Treasuries that has kept that sector in."

Agency yields are extremely low at the moment, and outright rate investors are selling their paper to look for better returns, the trader said.

"There's just been a general pushback in outright rates," the trader said. "We've had a pretty good rally here...There's been overseas selling as well."

The trader pointed out that spreads have widened by about 7 to 8 bps through the first half of the week, with the loosening around 10 bps further out on the yield curve in the 10-year sector.

"We've underperformed Treasuries and swaps," the trader said. "Swaps are out only maybe 3 to 5 bps."

Most of the selling has come from the outright rates community, the trader said.

"The rally to lower yields has prompted selling form those who are purely rate players," the trader said. "That means they don't hedge, and they buy on yield."

FHLB targets two-years

FHLB auctioned a $1.25 billion reopening of 1.625% Global Notes due July 27, 2011 at a yield of 1.243% on Wednesday, according to data from the agency.

The notes were sold at 100.728251 with a bid-to-cover ratio of 3.1.

The notes widened earlier in the day, expanding by about 3 to 4 bps, then recovered by about 1 bps to end at a spread of about 27 bps, the agency trader said.

"It definitely priced through the market at that time," the trader said.

The notes were last bid at about 28 bps, wider by about 4 bps from Tuesday, according to data by Tradeweb.

"I think the market had priced in expectations of a new two-years, so when it was announced that it was just an upsize, there was some selling of that issue in particular," the trader said.

Quiet week

The trader said the Street expects the Federal Reserve to target the short end of the yield curve when it announces its weekly open-market operations on Thursday "because they kind of skipped that the past few times," but added that market talk is not as robust this week.

"A lot of traders are out this week...you won't get a true flow until closer to Labor day," the trader said.

Joseph P. Savoie, managing director of fixed income sales and trading at Northern Capital, said: "August is always kind of a throwaway month."

Value in step-up callables

Savoie noted that agency spreads are "very very tight" at the moment.

"People are really playing a game of chicken with the Fed right now," Savoie said.

Smaller investors who are long agencies could be looking to take profit at the moment, he added.

"They could be long agencies, trying to take some off the table, and agencies could be good to sell off," he said. "But the question is, when you take that money off the table, what do you reinvest it in?"

Savoie said that for some investors, some step-up callables are now attractive again relative to high-grade corporate debt.

"Some people have been burnt in the past, the last rate cycle some people were marketing them the wrong way," he said. "People were buying these based on the final coupon, which they were never going to see. People are a little bit more savvy now, looking at the front coupon."

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