Agencies tighten on modest expectations that debt ceiling deal could emerge over weekend

By Kenneth Lim

Boston, July 22 - Agency spreads narrowed slightly on Friday as yields slipped on hopes that a deal on the U.S. debt ceiling could emerge over the weekend.

Bullet spreads came in by about half a basis point versus Treasuries at the front end of the yield curve.

"Real quiet day," a trader said. "Agencies have been tracking Treasuries rather than swaps because the debt ceiling debate is the biggest concern right now."

The callable sector saw active volumes, although trading was down a little ahead of the weekend.

"There's nothing really special going on other than it's a Friday in July," the trader said. "I guess the other thing going on is that the debt ceiling debate is creating a lot of uncertainty in the market, and when there's a lot of uncertainty investors can't do much."

Yields slip

Yield levels fell on Friday on cautious optimism about the negotiations over the U.S. deficit and debt ceiling. The Treasury Department has said that the debt ceiling has to be raised by Aug. 2 to avert default, but lawmakers in Washington have not been able to reach a deal.

Speculation mounted Thursday and Friday that the White House and congressional Republicans were close to a deal, although both parties have not confirmed the rumors.

Despite the lack of concrete evidence of progress, investors were buying Treasuries on Friday to hedge against a deal emerging over the weekend.

"I think the belief is that they're going to be working on a deal over the weekend, so there's a chance that something could be announced before we come back on Monday," the trader said. "The market seems to believe that a deal is going to get done, the only question is how close we're going to get to the deadline before we get a deal."

Guy LeBas, chief fixed income strategist at Janney Montgomery Scott, said the Treasury could actually have a little more time than it originally thought.

"The most interesting thing is Treasury tax receipts have come in $14 billion higher than expected, which actually gives the Treasury Department some breathing room," LeBas said. "It's looking like Aug. 2 is not the default date right now. If tax receipts meet earlier forecasts, then Aug. 10 will be the new deadline."

Concerns about Europe's debt crisis also took a back seat on Friday after European leaders agreed to extend bailout loan maturities and interest for Greece, Ireland and Portugal, buying those countries some time to address their debt burdens.

Key supply ahead

Investors will be focused on supply after the weekend, with the Treasury selling $99 billion of two-, five- and seven-year notes Tuesday through Thursday.

"Obviously with the concerns about the debt ceiling, it's going to be interesting how they do with the auctions," the trader said.

Fannie Mae also has an announcement on Benchmark Notes scheduled for Thursday, but the agency is expected to skip the calendar slot, the trader said.

"They just came with $5 billion of three-years last week, so I don't expect them to come again," the trader said. "They don't really have the needs."

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