Bullet agencies wider on profit taking, pressure from TLGP issues; investors flock to step-ups

By Kenneth Lim

Boston, Oct. 29 - Bullet agency spreads widened slightly on Thursday amid profit-taking and pressure from Temporary Liquidity Guarantee Program-backed offerings, while callable issuance continued to be strong.

Bullet spreads eased outwards as the market continued to face selling pressure, while accounts hunkering down for the month-end kept volumes thin.

"Spreads have been eking outwards the last couple of days, kind of across the curve," an agency trader said.

The loosening spreads were partly due to momentum from the previous afternoon, led by weakness at the front end of the yield curve, the trader said. The Fed had provided support for shorter-term notes early Wednesday by buying $5.358 billion of two- to four-year agency notes from the market, but the boost did not last long.

"The Fed came in yesterday...and they did buy a lot of paper, but it's the first time we've seen in a long time that after the buyback, spreads pushed wider," the trader said. "So obviously there was a lot of paper that people were trying to sell."

End of TLGP

Two large offerings of notes on Wednesday that were backed by the federal government through temporary liquidity guarantee programs also placed pressure on shorter-term agency securities. The TLGP offerings not only added to supply in the three-year sector of the curve, they also increased the number of short positions on corresponding agency bullets, the trader explained.

"There was a lot of TLGP paper, that put a lot of pressure on agencies," the trader said. "A lot of dealers having to take down the TLGP paper were using agencies as a hedge."

But agency spreads could return to a tightening path in the coming week once the Temporary Liquidity Guarantee Program, backed by the Federal Deposit Insurance Corp., issuance period ends on Oct. 31.

"We're going to see the relentless march to tighter spreads," the trader said.

Callables stay firm

Callable spreads held steady on Thursday as demand for structured products remain strong, said Michael J. Gladden, vice president of institutional sales at Mischler Financial Group.

"Callable spreads have stayed very much the same even as we've had a 10 bps to 12 bps shift in Treasury markets," he said. "And agency callables have stayed right along with that."

Gladden attributed the consistency to hunger for short-term products.

"There's still huge demand for short paper," Gladden said.

Step-up products are also driving a significant portion of demand as fears continue to mount of a rise in short-term interest rates.

"The step-ups are coming like five to 10 issues a day, and that's pretty unheard of," Gladden said. "There's a threat of rising interest rates. The GDP numbers were good, so if the economy recovers, the Fed will have to raise interest rates, and when that happens, the Treasury market's going to fall off, and when that happens people will want protection from step-ups."

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