Agencies widen as yield volatility drags on market amid uncertainties about Greece, FOMC

By Kenneth Lim

Boston, June 21 - Agency spreads widened slightly on Tuesday amid volatility in yields as the market faced uncertainty about the credit crisis in Greece and the U.S. economy.

Bullet spreads eased out slightly versus Treasuries on the day, although yields in general rose.

"Everything seems to be trading out to Treasuries," said Mary Ann Hurley, vice president of fixed income trading at D.A. Davidson & Co.

The callable market was more lively, with expectations of low interest rates leading to a fast pace of early redemptions by issuers. The redemptions have in turn led to demand for new paper.

"We're seeing a decent amount of activity, and a lot of paper seems to be put away, and a lot of people seem to want call protection because of the positive tone," Hurley said.

Most of the demand had been for one-year call protection structures, she added. Given the disappointing economic data that have characterized the second quarter of the year, the market is now expecting rates to stay low for quite a while.

"At the beginning of the year people were commenting on the expectations that 10s are going to hit 5%, and now they're not even talking about 4%," Hurley said. "The expectation now is around 3.25%."

Uncertainties widen spreads

Agencies underperformed on Tuesday as the volatility in yields kept up pressure on spreads despite a slight easing in fears about the stability of Greek sovereign debt.

Yield levels rose ahead of a confidence vote in the Greek parliament late in the day. The market bet - correctly, it turned out - that Greece prime minister George Papandreou would garner enough support to survive the confidence vote.

Greece's government may now find it easier to pursue further austerity measures that are a precondition to more aid from Europe and the International Monetary Fund.

"Because of the risk-on, risk-off trades associated with Greece, people just seem to be shifting to the safety of Treasuries," Hurley said. "That has been the trend that has been continuing for the past few days."

FOMC statement ahead

Investors were also wary about what the U.S. Federal Open Market Committee and Federal Reserve chairman Ben Bernanke may say on Wednesday after the central bank policymaking body's two-day meeting this week.

The Fed may have to address the weak labor and housing data that have been released over the past few months, as well as the end of the current $600 billion round of quantitative easing.

"Definitely we're going to be watching that," Hurley said. "I would expect him to just voice his concern about the economy, say interest rates are going to be low for an extended period, but I would not expect him to say that there's a QE3 coming down the line."

If the Fed stops buying additional Treasuries off the open market, that may not necessarily mean higher yields.

"Frankly that's going to be good for the bond market because the previous QE has helped risk assets," Hurley said.

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