Agency spreads tighten further on light volumes ahead of Thanksgiving; callable issuance takes a pause

By Kenneth Lim

Boston, Nov. 25 - Agency spreads continued to grind inwards on Wednesday as the market displayed ongoing strength heading into the Thanksgiving holiday.

Callable issuance, which had surged earlier in the week as Federal Farm Credit Banks prepared for coming calls, took a break and is not expected to come back much at all when the markets reopen on Friday.

Bullet spreads continued to narrow on Wednesday although market activity was "pretty quiet," said Michael S. Effron, head of U.S. government agency at Jefferies & Co.

"Agencies in general performed fairly well," Effron said. "Agencies tightened in versus Treasuries and swaps on the day. We've been seeing pretty much tightening in spreads all week."

Another trader also noted the tightening, but said some of the spread compression could be related to the rolling off of Treasuries.

"They look tighter, but that's really only the optical illusion of the roll off of Treasuries," the trader said. "In terms of absolute performance, not really, they're not getting that much better."

That roll-off effect could be at work again on Friday, the trader said.

"We get the seven-year roll today," the trader said. "I'm not sure what the roll on that is, but on Friday you're going to see seven-years 3 or 4 basis points tighter."

Callables take breather

Callable issuance slowed down on Wednesday, as was expected with the holiday, following a brisk pace in the first two days of the week.

FFCB was the standout issuer, accounting for about $2 billion of new callables on Monday and Tuesday, Effron said. The agency has been issuing callables because it has a sizable amount of notes that can be called soon, he added.

"Farm Credit is getting ready to refund or call a bunch of deals that were done earlier this year," Effron said. "So there's no balance sheet growth. They're basically just refunding."

The agency has issued notes in all sectors of the yield curve, but most of them came with very short calls of about three months, Effron said.

The other trader added that the current yield curve and low rates environment makes it attractive for issuers to reissue existing debt.

"Obviously with the steep curve and the tightening of spreads, any kinds of callable paper will get called," the trader said. "They're able to issue new ones at lower levels."

Positive break

The market will enter the break on a good note partly because the usual year-end buying may have come a little earlier, the trader said.

"There's better buyers of short paper," the trader said. "This year-end trade is happening a lot earlier than people expected. There's been a rush into short-term bills and that's spilling into everything else."

Even Temporary Liquidity Guarantee Program notes, which are backed by the Federal Deposit Insurance Corp., have recovered slightly after taking a beating the previous week.

"Guys were looking to buy FDIC paper," the trader said. "Those were hammered last week."

Effron added that FFCB is probably done with its callable offerings, which could ease supply.

"The market's strong, spreads have come in," he said. "There's a decent amount of supply out there, but I think Farm Credit's done. There'll be very little issuance or no issuance from Farm Credit on Friday."

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