Agencies narrower on session as yuan news sparks early tightening; Freddie Mac supply eyed

By Kenneth Lim

Boston, June 21 - Agency spreads capitalized on a morning surge to end the day a tad tighter after China said it would let the yuan appreciate.

Bullet spreads closed about 1 basis point tighter in the two- and 10-year sectors, while five-year spreads narrowed by about 2 bps on the day, said Michael Skinner, an agency trader with Wall Street Access.

"We walked into a tighter market after China overnight said they were going to go off the dollar peg...and any kind of credit spread tightened a little bit," Skinner said.

Callable issuance was decent, with Federal Farm Credit Banks and Federal Home Loan Banks pushing out a couple of decent auctions, he added.

"But I can't tell you that it was terribly active," Skinner said. "We did see some tightening off the bat, but they widened again later in the day."

Trading volumes were thin, but that was expected for a late-June Monday.

"[It's] kind of a typical summer Monday - very quiet," Skinner said.

Chinese boost

The market got a lift early in the day from China's weekend announcement that it would allow the yuan to appreciate against the U.S. dollar.

The move was initially seen as an immediate positive for the U.S. economy, which tightened spreads across the board. But persistent concerns about the debt crisis in Europe and China's emphasis that it will only let the yuan appreciate gradually led to weakness in the afternoon.

"I think, longer term, that China move means something, but in the interim we still have enough risk in the market that I don't think it's going to cause a big move in spreads," Skinner said.

Skinner expects that the market could see some correction soon given the agencies' tightening over the past week.

"We're near the most recent tights in the 10-year space...and the five-year came around 37 bps over the other day, so we have tightened significantly in the past week," he said. "We could see some widening."

Supply ahead

Investors this week will be watching Freddie Mac for a possible supply announcement on Wednesday.

"It's probably something in the front end again," Skinner said.

Investors are still hungering for new paper in the belly of the yield curve even though Fannie Mae just issued a series of new five-year Benchmark Notes two weeks ago, he added. But Skinner thinks that Freddie Mac will probably issue on the shorter end of the curve given current Libor levels.

"We could really use some stuff out a bit on the curve," Skinner said. "It's getting very tight there."

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