Agency curve steepens on hiatus in Greece headlines, looming Fed meeting; callables eyed

By Kenneth Lim

Boston, June 20 - Agency spreads widened slightly on the longer end of the yield curve Monday but held at the front end amid a slight easing in fears about Greece.

The bullet yield curve steepened as front-end spreads tightened slightly versus Treasuries on a tightening of swap spreads, but longer end spreads eased out a touch.

"It was pretty quiet overall, and agency spreads in general were a little bit steeper," an agency trader said.

Trading volumes were typically thin for a summer Monday, but activity was also dampened by a blank benchmark issuance calendar for the week.

"We're really just trading off other markets right now," the trader said.

Greece fears abate

Yields found a little bit of stability in the aftermath of a credit ratings warning on three French banks by Moody's Investors Service because of the financial institutions' exposure to Greek debt.

Moody's on June 15 put BNP Paribas, Societe Generale and Credit Agricole on review for possible downgrade, sending swap and agency spreads significantly wider. European leaders then backed off proposals to make Greece bondholders take losses, helping to relieve some of the pressure on spreads.

Spreads and yields were mostly stuck in a holding pattern on Monday amid the lack of headlines on the Greece issue, the trader said.

Investors were also looking ahead to the Federal Open Market Committee's meeting on Tuesday and Wednesday, with Fed chairman Ben Bernanke giving a press conference at the end of the meeting. The result of that meeting could move the markets depending on how the central bank's policymaking body views the economy.

The brewing crisis in Greece and the Fed meeting could lead to another volatile week for the market, with agencies mostly following the lead of the Treasury and swap markets, the trader said.

"You've just got to continue to walk in in the morning looking at whatever headlines are in Greece," the trader said. "You've got to stay prepared and stay nimble."

The covered bond market, meanwhile, has been struggling since the Moody's warning, because investors are once again concerned about the credit quality of issuers.

"I'm not saying we've got another Lehman Brothers on our hands, but...we saw spreads widen out there," the trader said. "At one point there was an offered market without bids because guys are still unsure about what the underlying risk is there in terms of the issuing banks."

Strong interest in callables

The callable segment remains active, especially after the rush in issuance as spreads widened after the Moody's announcement.

Issuers have also been active in redeeming older paper, giving a boost to issuance volumes.

"When you have that blow-out in swaps, callable coupons got pretty cheap for that 24-hour window, so there was a lot of printing then," the trader said. "Coupons that were printed mid to late last week are getting distributed handily."

Most of the callable issuance has been in the two- to three-year sectors.

"That's the sweet spot right now," the trader said. "It's the steep part of the curve and not too far out."

There was some speculation that some of the Federal Home Loan Banks may have already met their June funding needs, implying that callable supply could be thin going into the quarter end. That could have forced some investors into the market.

"I got a strange sense of a bit of short covering last week," the trader said.

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