Agencies tighten on safe-haven bids as Fitch cuts Greece rating; five-years soft on supply

By Kenneth Lim

Boston, May 20 - Agency spreads continued to narrow at the front end on Friday as a new round of flight-to-quality buying pushed yields lower.

Bullet spreads closed the day about 2 basis points to 3 bps tighter versus Treasuries in the two- to three-year sectors, an agency trader said. But the yield curve steepened, with spreads in longer maturities closing the day flat to 1 bp wider.

"It was good spread-wise today," the trader said. "We seem to have bounced off the earlier weakness in yields that we saw early Thursday."

The callable market saw substantial demand in the two- to three-year sectors, the trader said.

"There were big bank portfolios buying in callables," the trader said.

Part of the demand was spurred by a rash of redemptions earlier in the week from Federal Home Loan Banks.

"There was a big rollover in redemptions, especially with Home Loans," the trader said. "A lot of bonds got called earlier this week, and a lot of rollover money came back."

Yields slip on Greece worries

Yields slipped on Friday after Greece's credit rating took another hit.

Ratings agency Fitch Ratings cut Greece's rating by three notches to B+ with a negative outlook, spurring safe-haven buying ahead of the weekend.

"The rating downgrade reflects the scale of the challenge facing Greece in implementing a radical fiscal and structural reform program necessary to secure solvency of the state and the foundations for sustained economic recovery," Fitch said.

The front end of the agency yield curve benefited the most from the flight to quality, but the five-year sector was a little soft in the wake of Freddie Mac's surprising $1 billion reopening of five-year notes on Thursday.

"Five-years after the $1 billion reopening yesterday has softened up a little bit," the trader said.

Investors had been expecting Freddie Mac to pass or to offer notes in the two- to three-year sectors, so the Street was not prepared for a five-year reopening, the trader said. Demand was nevertheless strong for the deal, and supply has been thin anyway.

"Most auctions come through the screens a little bit, but this one came right on the screws," the trader said.

Tightening, supply ahead

Five-year spreads are likely to come back in because supply remains tight in that part of the curve, the trader said.

"I do expect five-years at some point to tighten here," the trader said. "We're a good 2.5 bps wider than before Freddie Mac announced the $1 billion reopening."

The week ahead could be quiet with the market closing early on Friday ahead of the Memorial Day weekend, the trader said. But supply in Treasuries could raise yield levels and attract some absolute-rate buyers.

"It's a short week, with no issuance in agencies," the trader said. "Obviously we have Treasury issuance, so I would probably look for accounts to maybe play that game and look to come in to buy on any concession in rates."

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