Agencies out with swaps as Greece default risk rises; talk of China support for Italy eyed

By Kenneth Lim

Boston, Sept. 12 - Agency spreads widened slightly Monday in sympathy with swaps as fears of a Greek default heightened, although a late report about China possibly buying Italian bonds pushed yields higher in frenzied trading near the close.

Bullet spreads lost ground early versus Treasuries during a choppy session, as worries about a potential Greece default fueled a flight to quality.

"The market initially came in wider with swaps more on panic about Europe, but it kind of reversed course during the day and ended mostly cheaper," an agency trader said. "But most of it was suffered late in the day."

Trading volumes were extremely light because of the high market volatility, which kept wary investors out of the water.

"There's no liquidity," the trader said.

Yields gain after early drop

Yields closed the day higher after an up-and-down session. The market returned from the weekend still worried about a possible default by Greece, which helped to lower yields initially as the stock market stumbled. Credit default swap spreads for European banks rose sharply in the morning.

But the Treasury Department had an unimpressive $32 billion auction of three-year notes, suggesting resistance to lower yields, which helped to nudge coupon rates higher.

The main news of the day, however, came just an hour before the close, with reports that Italy was talking to China about the Asian country's central bank possibly buying Italian bonds, which could help to lower Italy's funding costs.

The trader drew parallels between China's possible involvement in Italian bonds with billionaire Warren Buffett's investments in Goldman Sachs and Bank of America that helped to boost confidence in those banks. The key difference was that China was not expected to buy preferred stock with sizable dividends, which would be favorable for Italy, the trader added.

"That takes a big pocket to do that," the trader said.

The news about China pushed equities into positive territory just before the close, and swap spreads also came in, bringing agencies in from the day's wides.

"It's kind of like how stocks and swaps are trading," the trader said.

Europe in focus

The market will continue to focus on Europe in the coming days, the trader said.

"If we get any further improvement in news in Europe, this stuff's going to do a lot better," the trader said.

The market was also expecting possible supply from Freddie Mac on Wednesday.

"We have Freddie Mac on tap for Wednesday," the trader said. "My thoughts are a two-year or a five-year. Three-years improved today."

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