Agencies tighten as Japan's nuclear crisis spurs safe-haven bid; FHLB skips issuance slot

By Kenneth Lim

Boston, March 16 - Agency spreads narrowed slightly on Wednesday as the market continued to benefit from a flight to quality.

Federal Home Loan Banks also helped to support tighter spreads when it said it would forgo its March issuance slot.

Bullet spreads closed about 1 basis point tighter versus Treasuries in the two- to three-year sectors and about 1.5 bps narrower in the five-year sector. Longer maturities did not budge versus Treasuries.

"Agencies traded pretty well today," an agency trader said. "We didn't see a lot in the longer end, but we did have buyers for short-end bullets."

The callable market was quieter, with dealers stuck with inventory from a few weeks ago.

"Callables were pretty quiet," the trader said. "Guys are trying to sell deals that came in the last two or three weeks, but I think most guys are fairly full given the volatility in the rates market."

There may have been a touch of bargain hunting earlier in the day for cheap callable paper, the trader said.

"The market really just took off just before lunchtime," the trader said.

FHLB passes

FHLB said Wednesday that it would not issue new Global Notes in March.

The agency's next calendar issuance slot is on April 13.

The lack of supply took some of the pressure off of spreads, but investors were not completely surprised.

"It was not very unexpected," the trader said. "They don't have much in the way of funding needs right now."

Wednesday's tightening was a bit puzzling in light of the sharp drop in Treasury rates following weak housing starts data and a brewing nuclear crisis in earthquake-hit Japan.

"In terms of bullets, I was surprised," the trader said. "Usually when the market runs up you see better selling, but today we only saw sellers at the long end, and better buyers at the short end."

Trading volumes on Wednesday were also robust, but activity could dwindle if rates continue to fall and price out potential buyers.

"If we continue to run up, I would think volumes would dry up," the trader said. "People don't want to make any big trades right now. Maybe people will buy some duration, but I don't think it's going to be a lot."

Japan crisis in focus

The market was focused on Japan's developing nuclear crisis on Wednesday leading into the close, the trader said.

Fears of an eventual meltdown heightened when Gregory Jaczko, the head of the U.S. Nuclear Regulatory Commission, said spent fuel rods at a nuclear reactor in Japan were completely exposed, implying that there was no water in the containment pools to cool them.

Guenther Oettinger, the European Union's energy commissioner, also told a European Parliament committee that the nuclear plant was "effectively out of control," although the commissioner later clarified that his assessment was based on already known information.

But reports late in the day of progress in getting a power line to the nuclear plant, which could restore cooling systems, gave some hope of relief.

"We've been talking about it here," the trader said. "I think it's about 2-to-1 odds that we get higher rates when we come in tomorrow, but it's like a 5 bps move for the two scenarios where you get higher rates and a 10 bps move for the one scenario with lower rates."

The trader was ending the day slightly short on rates, based on the belief that the market may have been overbought on Wednesday, albeit by only a little bit.

"It's pretty tricky," the trader said. "I've been surprised by how much the market has been affected by the overseas news, because although what happened in Japan was a great human tragedy, in economic terms it shouldn't have that much of an effect in the U.S."

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