Agencies end unchanged in half-day session as market shrugs off S&P outlook downgrade

By Kenneth Lim

Boston, April 21 - Agency spreads closed flat on a quiet Thursday, although the callable market showed hints of a busy comeback after the long Good Friday and Easter weekend.

Bullet spreads closed the day unchanged versus Treasuries, with volumes extremely light because markets were only open for half the day. The five-year sector underperformed slightly, but front-end spreads stayed firm and tight.

"It's quiet today," an agency trader said. "For the most part spreads on the week are really trading within a range with a lot of people out this week on vacation."

The trader added that the strong Treasury market over the past week also dampened interest from buyers, who would prefer a cheaper entry point.

"The rally in Treasuries has kind of defused some of the enthusiasm for fixed income buying right now," the trader said. "Whenever we get rallies like this, their instinct is to sit on their hands and wait for a pullback."

Investors hoping for supply have to wait until April 28, when Freddie Mac has an announcement on Reference Notes. Fannie Mae on Wednesday said it would skip its April 20 issuance slot.

"Fannie Mae announced they were passing, which was not a surprise given the illiquidity in the market right now, and given that they have two slots in May," the trader said.

The market shrugged off Standard & Poor's late-Wednesday downgrade of the outlook for agency debt to negative from stable. The credit ratings agency said the cut, which affects Fannie Mae, Freddie Mac, Federal Home Loan Banks System and Farm Credit System Banks, was to keep in line with an earlier and similar cut in the outlook for U.S. government debt.

"It was kind of the same thing," the trader said, suggesting that the market had already priced in the move.

FHLB callable demand rises

The callable market was a little more robust than bullets, although demand remained focused on shorter-term paper.

"In general I think there's been a fair bit of activity in callables," the trader said.

The trader said a small surge in redemption notices recently suggest that callable issuance could pick up soon as investors seek to reinvest money from notes that have been taken out.

"I was just going through some redemption notices of bonds being called, and investors are getting money back in their pockets that they're going to have to deal with," the trader said.

FHLB coupons look cheaper

Investors have also been picking up more callables from FHLB because coupons from that issuer are looking more attractive after Fannie Mae and Freddie Mac callable spreads have been slipping.

"From a funding standpoint, one thing I've noticed is richening in both Fannie Mae and Freddie Mac on callable issues, so now you're seeing a fair amount of Home Loan paper printing simply because it's cheaper," the trader said.

The trader said FHLB callables looked about 5 basis points to 10 bps rich about three to six months ago but are now cheaper than where Fannie Mae and Freddie Mac are. The relative cheapening is mostly the result of Fannie Mae and Freddie Mac richening.

"Freddie Mac, for example, has noticeably richened its funding levels, particularly in the front end, and Home Loan has been unchanged...which is a direct result of Freddie Mac not having needed as much funding," the trader said.

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