Agencies slip versus Treasuries; Freddie Mac surprises market with five-year offering

By Kenneth Lim

Boston, July 6 - Agency spreads widened slightly on Wednesday as concerns about Europe continued to grow a day after a ratings downgrade on Portugal.

The market also came under slight supply pressure as Freddie Mac announced an offering of five-year notes that caught investors by surprise.

Bullet spreads closed the day modestly wider versus Treasuries. Agency spreads were nevertheless stronger versus swaps, which bore the brunt of Europe-related concerns.

"Swaps are wider on concerns about the Portugal news overnight, but agency spreads have recovered and outperformed swaps on the day," a trader said.

The callable market slowed down slightly on the pullback in coupon levels amid this week's Treasury rally.

"When you had that back-up on Thursday and Friday, there was a fair bit of buying that went on as people on the Street hoped to take down that coupon," the trader said. "But things have slowed down mildly as rates kind of moved lower."

But callable activity should remain active in the weeks ahead if only because of a large amount of money that needs to be reinvested.

"There has been a huge, huge amount of redemptions over the last two weeks or so," the trader said.

Portugal downgrade eyed

Investors continued to shift away from risk assets in the aftermath of Moody's Investors Service's decision on Tuesday to cut Portugal's debt rating by four notches to Ba2.

The new rating is two ranks below investment grade.

Yields fell for the second straight day as the news led investors toward safe-haven assets. The shift back into Treasuries hit all spread products, although agencies weathered the flight to quality better than swaps.

"Agencies in general have outperformed today," the trader said. "There's been good buying."

Freddie Mac surprises

The five-year sector also came under slight pressure earlier in the day after Freddie Mac announced an unexpected offering of Reference Notes.

The agency plans to sell five-year notes on Thursday, talked at a spread of 33.5 basis points over Treasuries.

The size of the deal has not been set, but it is expected to be at least $3 billion.

Barclays Capital Inc., Citigroup Global Markets Inc. and UBS Securities LLC are the lead managers.

The order book easily reached $3.5 billion early Wednesday, suggesting that demand is strong for the deal, the trader said.

Price talk represented a concession of about 2 bps to surrounding issues. The issuer will probably price the deal at 33.5 bps over Treasuries simply because Freddie Mac does not usually veer off price talk by very much.

"Unless we tighten significantly I don't see them tightening price talk," the trader said, noting that the existing Freddie Mac notes due May 16 narrowed by about 1 bp to a spread of 20.5 bps bid late Wednesday.

That older Freddie Mac issue widened by about 1 bp early in the day after the deal was announced because the market had not been expecting the agency to come with a deal just a week after a $5 billion three-year offering.

"I really thought they were going to pass, just given the deal they did last week," the trader said. "But as somebody told me, if the funding's there, you take it."

The funding cost is slightly below Libor, which is attractive for the five-year sector.

"Even though they may not have overwhelming needs, the opportunity to come in and term out some funding made sense," the trader said.

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