Agencies narrow as wide spreads attract safe-haven bidders amid concerns over French banks

By Kenneth Lim

Boston, Aug. 10 - Agency spreads narrowed Wednesday as investors sought bargains amid a flight to quality on the back of renewed concerns about Europe's debt crisis.

Bullet spreads came in about 3 basis points tighter on the day.

"It looks like agency spreads kind of snapped back in by the few basis points that they widened out by on Monday," said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott. "It kind of happened pretty early on, and late in the day the action quieted down a little."

Callables remained in good demand as prospects of higher yields dimmed following the Federal Reserve's statement on Tuesday that it would keep short-term interest rates at the exceptionally low range of zero to 0.25% until mid-2013.

"There was fairly robust issuance on the callable side," LeBas said, noting "pretty good demand from money managers."

Issuers were also hoping to take advantage of the currently low yields.

"We saw a number of callable deals price, more so than the last couple of days," LeBas said. "It seemed like issuers were trying to get in on the low-yield environment."

Yields fall further

Yield levels continued to decline Wednesday as concerns about French banks' exposure to Greek debt sparked a fresh round of safe-haven bids.

The market confronted speculation early in the day about the credit stability of French banks because of their exposure to bonds issued by Greece, which is struggling under a mountain of debt. The concerns extended to France itself, with fear that the country could be the next target of a downgrade after Standard & Poor's action on the United States a week ago.

"It was the fear trade continuing," LeBas said.

Money consequently poured into Treasuries, pushing yields lower for the third straight session. Agencies would normally lag Treasuries in a flight to quality, but spreads had been pushed out so much in Monday's downgrade-driven sell-off and yields were so low that investors were comfortable with picking up a little more risk even as they fled Europe and equities.

"The market was getting out of anything that wasn't safest on Monday, but that has abated since that day," LeBas said. "It's like on Monday we crashed the car, and on Tuesday and Wednesday we picked through the wreckage to see if we could find anything of value."

FHLB skips issuance

The agency market has also been relatively free from supply pressure, with what will now turn into a roughly full month without benchmark issuance.

Federal Home Loan Banks on Wednesday said it will not use an issuance slot to offer new Global Notes this week, leaving the agency until September 7 for its next calendar opening.

The next agency on the issuance calendar is Fannie Mae, with an announcement on Aug. 16.

The last benchmark offering was on July 20, with FHLB selling $3 billion of two-year notes.

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