Agency spreads flat as Treasuries, equity markets hold sway; Freddie Mac two-year deal eyed

By Kenneth Lim

Boston, Sept. 22 - Agency spreads had another flat session on Tuesday as a strong stock market and supply from the Treasury kept rate investors looking elsewhere.

Agency spreads closed unchanged across the yield curve on Tuesday, an agency trader said.

"Things were pretty slow today in bullets," the trader said. "Spreads were flat to slightly wider around the belly of the curve."

Callable issuance picked up after a slow Monday.

"We saw good flow in callables," the trader said. "Yesterday was kind of quiet, but today was better. It's still mostly step-ups because of the back up in rates; investors are looking for better yields."

Secondary trading activity was still sluggish because of excitement in other markets, the trader said.

"I guess there's nothing really going on in agencies today to give investors any kind of a strong reason to be trading agencies," the trader said. "We had the Treasury auctions. That was occupying the rates guys, and the stock markets were also doing really well, so that probably kept some money away from debt markets."

Treasury auction goes well

The U.S. Treasury sold $43 billion of two-year notes on Tuesday with a bid-to-cover ratio of 3.23, one of the strongest auctions in the past few months.

Cantor Fitzgerald's George Gonzales, chief fixed income rates strategist, wrote in a note that the Treasury offering was "one of the better auctions since June."

"Another day goes by where it is starting to feel like the movie 'Groundhog Day' where good front-end auctions and demand for USTs repeat," he wrote. "This should continue...for the time being as alternatives for liquid securities are limited to govies. This idea is pretty widespread and is allowing carry players to continue on (with no worry over supply or the Fed this week)."

But Gonzales warned that a sharp step-up in short-term rates could "wipe out the easy money from roll down and carry trades." Such a move by the Fed could be driven by the central banks' need to support a number of competing markets while maintaining inflation and employment, Gonzales added.

"The Fed...has the ability to be creative with its unwind - buyer beware," he wrote.

Freddie Mac five-year possible

Freddie Mac could offer new Reference Notes in the two-year sector on Thursday, the agency trader said.

"They haven't done a two-year in a while, and the Fed just bought up some two-years, so there's some demand there, and the funding levels are good in that sector," the trader said. "That being said, I don't think the market's expecting anything big. They don't really need the funding, which is why we've been seeing all these small deals and reopenings."

Any deal by Freddie Mac will probably receive a strong response from investors, the trader said.

"There's still a lot of demand in the market for agencies," the trader said. "With the Fed buying up agencies every week and Fannie Mae and Freddie Mac trying to shrink their portfolios, the market's not getting the kind of supply it's looking for."

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