Spreads widen in quiet session, stage late recovery; Fannie expected to skip calendar opening

By Kenneth Lim

Boston, Aug. 25 - Agency spreads weakened again on Wednesday on early widening, although the market closed the gap versus Treasuries late in the day.

Bullet spreads closed flat to half a point wider on the day.

"Agencies started off with a pretty bad tone, with some widening, and then we kind of found our footing later into the session," one agency trader said.

Callable issuance has been slow with the recent drop in rates, with the low yields making it difficult to attract investors.

"Callables in general have been pretty slow," the trader said. "Yields went so much lower, I think people got a little bit of sticker shock in callables."

But Wednesday's afternoon pullback in Treasury prices could reignite the callable market.

"I have a sinking feeling we might see more activity tomorrow because we have this late-day sell-off," the trader said. "Rates are wider, so they may be able to print some coupons that are appealing to people."

Positive ending

Despite the wider spreads, the late narrowing was heartening, the trader said.

"We saw some buying emerge in longer-dated paper," the trader said, adding that, "Spreads stabilized a little for the first time in a while."

An agency analyst said spreads will probably stay within a narrow range from now until after Labor Day on Sept. 6.

"I don't expect anything much to happen between now and Labor Day," the analyst said. "The markets are kind of quiet on the trading front and the news front."

The Treasury market's drop on Wednesday also suggested that rich valuations in government debt could be facing some resistance.

"The selloff in Treasuries in the face of weak housing sales and disappointing durable goods orders is a sign that the market has priced in most of its fears in the short term," the analyst said.

"I don't see Treasuries rallying much further, and on those lines, I don't see agencies having a lot of reason for moving much either."

Fannie Mae could skip

The trader said that Fannie Mae will probably decide to skip its next calendar issuance slot for Benchmark Notes on Thursday.

"The market has not been trading very well, there's a lot of widening, a lot of selling, and funding levels are not appealing for issuance," the trader said.

Spreads against Libor are currently about 8 bps over for five-years, 1 bp below for three-years and two below for two-years, the trader explained.

"In general, that's not very appealing," the trader said.

The slow market - "this is one of the slowest weeks in August," the trader said - could also make it harder to sell a new note and lead Fannie Mae to wait until its September slot.

"All of that combined leads me to believe they're going to pass tomorrow," the trader said.

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