Agency spreads creep tighter as Greece bailout eases fears; Europe remains key theme for week

By Kenneth Lim

Boston, May 10 - Agency spreads closed flat to slightly tighter on Monday as governments on both sides of the Atlantic announced plans over the weekend to address the debt crisis in Europe.

Bullet spreads ended mostly unchanged on the day despite early tightening, giving up ground in the afternoon as investors bypassed the market for slightly riskier fare in high-grade corporates.

"We came in with a much better tone than before the weekend," said Michael Skinner, an agency trader at Wall Street Access.

"Agency spreads were tighter but not as much as corporates. Corporates rebounded much more than agencies did."

Callable spreads narrowed as volatility retreated.

"Callables got tighter because volatility came down," Skinner said. "That market's gotten richer."

Europe eases fears

The market emerged from the weekend buoyed by bailout plans aimed at containing the debt burden in southern Europe.

European officials and the International Monetary Fund announced on Sunday a €750 billion loan program to provide a lifeline for southern European countries. Greece, Portugal and Spain have been the recent targets of concerns about their credit health. The U.S. Federal Reserve also reopened dollar-swap lines to improve liquidity in the European banking systems.

"My thinking is that the bailout in Europe is going to help, but it still remains to be seen whether it's enough," Skinner said. "It's a large umbrella of nations there. When we did it here, it was just one country."

The news brought agencies closer toward Treasuries early Monday, Skinner added.

"We started off tightening, anywhere from 2 to 5 basis points, depending on the part of the curve," he said.

"We're going out not too much different from where we closed on Friday. We gave back about three-quarters of the initial tightening."

The afternoon slip was mostly a function of investors losing some interest in agencies and looking elsewhere for better yields, Skinner explained.

"Investors' minds were elsewhere," he said.

Fannie Mae in background

Fannie Mae on Monday announced a first-quarter loss of $13.1 billion and said it would need to tap the U.S. government for another $8.4 billion.

The news was "not that big of an issue now" with the Treasury having said that it would fund Fannie Mae and Freddie Mac for as much as needed until the end of 2012, Skinner said. Nevertheless, markets and regulators are hoping that the housing agencies recover sooner rather than later.

"They kind of put those on the backburner for now [...] But I think the government's hoping they stop losing money from now until [2012]," he said.

Federal Home Loan Banks has a calendar announcement on Global Notes issuance on Wednesday, and a front-end offering is most likely, Skinner said. But the rest of the week should continue to be driven by sentiment about Europe.

"We're going to continue to watch Europe and watch Libor everyday, and how that affects stocks and the euro, and trading off that," he said.

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