Agencies tighten as Moody's cuts Ireland to junk; Fannie Mae could offer three-year notes

By Kenneth Lim

Boston, July 12 - Agency spreads narrowed Tuesday on a broad flight to safety after Moody's Investors Service cut Ireland's credit rating to junk.

Bullet spreads tightened by about 1 basis point versus Treasuries and flat to mixed in later maturities.

"Agencies outperformed both swaps and Treasuries," an agency trader said. "We've participated in a little bit of the flight to quality today."

The callable market continued to see strong issuance volumes. The most popular deals were three years and shorter for fixed-coupon issues. Step-up structures saw more activity in issues with maturities that are four years and out.

"Callables are very busy," the trader said. "We've just been printing and printing new issue deals across the board."

Callable issuance has mostly been driven by reinvestments, with investors flush with cash after a recent wave of early redemptions.

Issuers have been calling back their old callables because of the low interest rate environment and expectations that rates will remain low. At the same time, investors are willing to put the money back into callables because it is hard to find higher yields.

"I would say the majority of the redeemed money is getting recycled back into the callable market," the trader said. "It's just the highest yielding part of the agency market."

Ireland downgraded to junk

Investors bought into safe-haven assets on Tuesday after Moody's downgraded Ireland's debt rating by one notch to Ba1 with a negative outlook.

The credit ratings agency cited for its decision the likelihood that Ireland will need more aid before it can tap capital markets again.

Ireland became the latest peripheral European country to come under fire from credit markets in recent weeks, with Portugal also being downgraded to junk by Moody's recently. Greece continues to need bailout money to stem its debt crisis, while Italy was the target of speculation on Monday.

The market's uneasiness about Europe has led swap spreads to lose significant ground against Treasuries. Agencies followed swaps wider earlier in the morning before bouncing off the wides and have generally performed better than swaps.

"We did underperform Treasuries when swaps were widening out, but we did outperform swaps on the widening move," the trader said. "We've become viewed as almost a pseudo Treasury type of investment, particularly in the front end. On any kind of back-up or widening, when investors need to buy they do come in to agencies."

Fannie Mae ahead

The market was split about whether Fannie Mae would announce an offering of Benchmark Notes on Wednesday.

On one hand, funding levels are attractive at the moment. But if swaps widen further on new Europe concerns, Fannie Mae could decide to wait another two weeks when it has another calendar slot on July 28.

"It's kind of 50-50 at this point," the trader said. "If they do come with a deal, I would say it's probably less contingent on funding levels...and more on macro factors."

If Fannie Mae comes to market, it will probably bring an offering of three-year notes, the trader said.

"Three-years is the sweet spot, both for issuers and investors [because of the steepness of the curve in that sector]," the trader said.

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