Agencies flat on supply uncertainties, pending Bernanke remarks; FHLB expected to pass

By Kenneth Lim

Boston, June 7 - Agency spreads closed flat on Tuesday as investors grappled with uncertainties surrounding supply and a late-in-the-day speech by Federal Reserve chairman Ben Bernanke.

Bullet spreads ended the day unchanged versus Treasuries, which also ended the day almost flat.

"Spreads are pretty much unchanged today," said Guggenheim Partners head of agency trading Mike Goldman. "They tried to do better for a little bit this morning, maybe about half better, but they gave it back in the afternoon."

The callable market, however, was slightly robust, with some buying seen across the board.

"Some of the secondary stuff has been selling pretty well," another trader said.

Trading volumes remained muted with low yields and uncertainties keeping money on the sidelines.

"A lot of people [are] playing the waiting game," the trader said.

Yields seesaw

Yields initially rose early Tuesday as the first of three Treasury auctions began, with a $32 billion offering of three-year Treasury notes.

The auction saw good demand, but that was not a big surprise for the market.

"The flight-to-quality bid and overseas demand are especially pronounced in front-end issues," the trader said. "Threes were expected to do well, and they generally do."

But investors were quick to buy up short maturities in the afternoon before a speech by Bernanke. The Fed chairman was expected to provide his views on the state of the economic recovery and inflation.

In his speech, Bernanke said economic growth this year has been slower than expected but should maintain a decent pace over the year.

"With the effects of the Japanese disaster on manufacturing output likely to dissipate in coming months, and with some moderation in gasoline prices in prospect, growth seems likely to pick up somewhat in the second half of the year," he said.

He also expressed his belief that the impact of the recent increase in oil and food prices is only temporary, noting that projections of 10- and five-year inflation rates have remained stable. Bernanke added that a sustained jobs recovery is the key factor in policy decisions.

"Although it is moving in the right direction, the economy is still producing at levels well below its potential; consequently, accommodative monetary policies are still needed," he said. "Until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established."

Goldman noted that agency spreads have been "leaking wider" the past few weeks, and could see snap back if there is a good back-up in yields.

"There's no supply," he said. "I think part of it is the yields are so low people don't want to buy, but at some point we have to eventually get a backup."

FHLB could pass

The market is not expecting Federal Home Loan Banks to announce a big offering of Global Notes in its calendar slot on Tuesday.

"Most likely a pass," Goldman said. "If they do anything it will be in the front end."

Although funding costs are very attractive for issuers at the moment, FHLB simply does not need a lot of funding at the moment with the housing market still struggling.

"It's more their needs than anything," Goldman said.

FHLB has also been active in the callable market.

"Home Loans has recently done a whole bunch of auction business in callables, and that will lessen their need," Goldman said.

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