Agencies tighten amid Moody's warning on U.S. debt; Fannie Mae deal draws strong interest

By Kenneth Lim

Boston, July 13 - Agency spreads narrowed on Wednesday as Treasury yields rose after a credit rating agency warned of a possible downgrade of U.S. government debt.

Fannie Mae announced an offering of three-year Benchmark Notes, and strong demand from investors sparked speculation that pricing could be tightened.

Bullet spreads closed the day out by 2 basis points versus Treasuries, while callable spreads came in by about 4.5 bps to 5 bps.

"Agencies have done very, very well today," an agency trader said. "Mostly swaps and volatility came in."

Callables continued to see strong volumes with investors seeking to reinvest the massive amounts of money that have been returned over the past several weeks amid a high rate of redemptions. Callable redemptions are averaging about $60 billion a month, the trader said.

Yields rise on warning

Yield levels rose on Wednesday after Moody's Investors Service said it was putting U.S. government debt on review for a possible downgrade of its Aaa rating.

The agency said it would cut the country's sovereign rating if lawmakers cannot agree on a deal to raise the debt ceiling by the Aug. 2 deadline.

The news came in the afternoon and sparked a sharp sell-off in Treasuries. Swaps consequently came in versus Treasuries, and agencies followed suit.

"Yields were actually lower up until the negative outlook came out," a Treasury trader said. "Frankly speaking, I think the market was ready for a pullback with the long bond auction tomorrow and the extremely strong rally over the past week. The kindling was already gathered, and Moody's just provided the spark."

The Treasury trader thought that U.S. lawmakers would be able to avert a default by the U.S. by reaching a deal but noted that confidence is not as high as it was previously.

"I still think they'll be able to get it done," the trader said, "because they'd be really, really stupid not to. If they want to keep their jobs after the next election, they'd better get it done...Unfortunately, every time we think Congress can't get any worse, they prove us wrong."

Fannie Mae plans deal

Fannie Mae found strong demand for its planned offering of three-year Benchmark Notes, which will price Thursday.

The agency announced the offering Wednesday, with price talk set at 29 bps over Treasuries, market sources said.

The size of the offering has not been set, but it is expected to be at least $3 billion.

BNP Paribas Securities Corp., Deutsche Bank Securities Inc. and Goldman Sachs & Co. are the lead managers of the offering.

"I hear it's going very, very well," the agency trader said. "I think the book is very good."

Price talk could be narrowed based on the sharp tightening in agencies late Wednesday.

"There's a really good chance," the trader said, "based on what happens tonight, they might tighten it one to half a basis point."

The deal did not come as a surprise for the market, the trader added, noting that demand for safe-haven assets remains high.

"Think about what's been going on," the trader said. "A lot of people are taking a lot of risk off. Commodities have been hit pretty hard...That's one reason why auctions have gone so well this week even though yields are basically lower."

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