Agency spreads unchanged as market eyes Treasury auctions; FHLB deal likely small: trader

By Kenneth Lim

Boston, Sept. 8 - Agency spreads were mostly unchanged on Tuesday with fixed-income investors mostly focused on a strong Treasury auction, market sources said.

"It was very, very slow in the agency markets," said Thomas L. di Galoma, head of fixed-income rates trading at Guggenheim Capital Markets. "Swaps are a little better bid, but agencies just really aren't trading."

Di Galoma said the level of activity was probably still reflecting the lethargy from the summer months and the recent Labor Day weekend.

Treasuries in spotlight

Investors on Tuesday were more excited about the Treasury's auction of three-year notes, which met expectations for a strong sale.

The Treasury sold about $38 billion of three-year notes at a high yield of 1.487% with a bid-to-coverage ratio of 3.02, one of the stronger offerings in the sector in some time.

"I thought demand was once again over the top for the three-years," di Galoma said. "Indirects were better at mid-50s on a percentage basis...the U.S. has got somebody extremely involved in buying their debt. We think the bids are coming from overseas. Certainly some domestic players are picking up Treasuries here as well. It's definitely been helped by some moving out of high-yield corporates and high-grade corporates."

John Bucci, vice president at Gurtin Fixed Income Management, agreed that the auction went "incredibly well," but noted that all Treasury offerings at the short end of the yield curve have been strong.

"It shows that there's still very high demand for safe liquid assets with short duration," Bucci said.

Volatile opportunities

Treasuries and agencies at the short end of the curve are quite similar at the moment because of continued government backing of agencies, and part of the spread is a matter of liquidity, Bucci noted.

But he added that volatility is higher in the agency space.

"There's still opportunities [in agencies], especially with the Fed being the marginal buyer in there," he said. "It continues to be a volatile market on the short end depending on what the Fed does any one day and how the market perceives it."

The higher volatility applies to callables as well.

"Today callable agencies, on an option-adjusted basis, are trading right on top of Treasuries," Bucci said. "But again this fluctuates quite a bit."

FHLB announcement Wednesday

Federal Home Loan Banks is scheduled to make an announcement on its Global Notes offering for the month on Wednesday, but only a small deal is expected, di Galoma said.

"We think they might pass or do something in the shorter end," he said.

In its August funding, FHLB sold $1.25 billion of two-year notes in a reopening of its 1.625% notes due July 2011.

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