Agencies mixed as flight-to-quality bids keep spreads at tights; Fannie Mae supply ahead

By Kenneth Lim

Boston, Feb. 28 - Agency spreads closed mixed on Monday as ongoing unrest in Libya and the Middle East supported demand for safer investments.

Bullet spreads ended the day unchanged overall versus Treasuries, an agency trader said.

"Spreads are modestly better in the back end, modestly better to a touch cheaper in the front end, pretty much mirroring swaps," the trader said. "We did improve versus swaps in the front end of the curve."

Joseph J. Riley, senior managing director of institutional sales and trading at Mesirow Financial said callable activity was also muted.

"The calendar has been on the quiet side," Riley said. "We have probably been involved in maybe half a dozen deals between Friday and today, but they were all small deals...there hasn't been a deal that was index size."

Volumes continued to be depressed.

Little extension trading

Despite the lack of activity, the overall tone of the market reflected an unwillingness to ease off of current tights.

"The trades we saw were all buyers," Riley said. "No one is in the mood to be short with the geopolitical problems that we're seeing. Spreads were unchanged on the day, and not a lot of business, but what we saw was coming from real money buyers."

Agencies, however, did not see much in the way of extension trades with the month-end.

"The agency extension index today was 0.00 and it reflected the kind of day we had," the other trader said. "Treasuries were up because of a big month-end extension, but agencies had no extension so we just marked time.

But Riley, who said "not very many accounts were active" on Monday, said the market was a touch uncomfortable with the tightness in spreads. Without the flight-to-quality bid that is stemming from the Mideast protests, agencies would probably be quite a bit wider, he said.

"It's clearly overdone on the upside," he said.

But investors are reluctant to take short positions because nobody knows when or how the unrest will be settled.

"It's going to take so long because there are so many ramifications of this," Riley said. "Are we talking about regime change? Do hard-line anti-Western governments form after regime change? Is there a spillover effect that will spread to the rest of the region? There are a lot of unanswered questions and they serve to keep oil prices high, which will be a significant drag on the economy."

"In the short term I don't see any reason to be short," he added.

Fannie Mae ahead

The market could see some supply this week if Fannie Mae decides to issue notes.

The agency has a calendar announcement on Benchmark Notes on Tuesday. Fannie Mae skipped its previous calendar slot on Feb. 9 and last sold Benchmark Notes on Jan. 28 in a $5 billion offering of three-year paper.

Investors have not seen any benchmark-sized bullet supply in about two weeks after Freddie Mac also passed on its calendar slot on Feb. 24.

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