Agencies slip near finish as S&P cuts GSE outlooks on U.S. debt concerns; Fannie Mae passes

By Kenneth Lim

Boston, April 20 - Agency spreads came under late pressure on Wednesday as Standard & Poor's cut its outlook on debt issued by government-sponsored enterprises in light of its recent action on U.S.-issued paper.

"We're about 1 basis point wider from yesterday's close," an agency trader said.

Agencies did nothing for most of the day as volumes languished in the holiday-shortened week. Thursday's bond markets close early, and Friday is a market holiday for Good Friday.

"It's obviously a holiday week," the trader said.

The callable market also took it easy, with most of the activity at the front end of the yield curve.

"We've been printing the front end in agency callables, but it's just kind of low participation," the trader said.

S&P cuts GSE outlooks

S&P on Wednesday said it was cutting the debt outlook to negative from stable for Fannie Mae, Freddie Mac, Federal Home Loan Banks System and Farm Credit System Banks.

The ratings agency also lowered the outlook in a similar fashion for all the individual Federal Home Loan Banks except for the banks in Boston and Seattle. The ratings on individual Farm Credit banks were also left unchanged.

S&P said the move was in line with the company's decision on Monday to downgrade the outlook for U.S. government debt to negative from stable. Concerns about mounting U.S. budget deficits and growing debt levels were cited for the move.

Because the U.S. government is the assumed ultimate backstop for debt issued by the agencies, the outlooks and ratings of GSE debt has to reflect the credit quality of the U.S. government, S&P said.

"We will not raise our outlooks and ratings on these entities above those on the U.S. government as long as the ratings and outlook on the U.S. remain unchanged," S&P said in a statement. "Conversely, if we were to lower the ratings on the U.S., we would also likely lower the ratings on the debt of these [government-related entities] as well as our issuer credit ratings on relevant individual GSE entities."

The news came just before the market's close, which limited the market's reaction, but investors may not be too worried, the trader said.

The S&P move was "not unexpected and kind of par for the course," the trader explained, adding that "no one's really reading anything new into the headlines."

"I do think the market's acting appropriately," the trader said. "I think most people are brushing it off, but any rise in yields based on the fact that the U.S. has been downgraded to negative...that should basically be the proper amount that you see in agencies as well."

The fact that the S&P downgrades came in the holiday-shortened week may have helped to dampen market reactions, the trader said.

"I don't know if they planned it this way," the trader quipped.

Fannie Mae skips issuance

For most of the day, trading was lackluster, especially after Fannie Mae said it would not use its calendar slot to issue new Benchmark Notes this week.

The housing finance agency's next issuance announcement date is May 3.

The pass was no surprise for investors, because Fannie Mae's funding needs are not great and the short week may make selling difficult.

"I think everybody was expecting a pass or a two- or three-year," the trader said.

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