Agencies tighten as Italy auction, Moody's warning push yields up; Fannie Mae sees demand

By Kenneth Lim

Boston, July 14 - Agency spreads narrowed modestly on Thursday as Treasuries slipped on ongoing concerns about the country's credit rating and amid an easing of Europe concerns, while Fannie Mae found strong demand for an offering of three-year debt.

Bullet spreads closed the day a touch narrower versus Treasuries, in line with swaps.

"Spreads overall have kind of held in today," said Michael Skinner, an agency trader at Wall Street Access. "I can't say that it's been a total risk on as you see stocks close lower...but right now agencies are kind of following swaps."

The callable market fizzled a little amid the spike in volatility.

"Callable activity has been sporadic," Skinner said. "Some of the stuff has been languishing. Last month seemed to be busier in callable land in terms of redemptions, but this month has been a little quieter."

Yields creep higher

Yields rose on Thursday on a combination of factors.

In Europe, Italy sold €4.96 billion of Italian Treasury bonds, coming at the high range of early indications and easing concerns about the country's ability to tap capital markets.

"Treasuries are down because Italy had a very successful bond auction today," Skinner said.

The day's economic data was also slightly positive, with new jobless claims declining by 22,000 to 405,000 in the previous week.

There was also a trace of wariness in the aftermath of Moody's Investors Service's announcement late Wednesday that it was reviewing the U.S. government credit rating with a negative outlook. U.S. debt will probably be downgraded if lawmakers cannot agree on a deal to raise the debt ceiling before Aug. 2.

But the impact of the Moody's announcement was slightly muted because the market was not entirely surprised, Skinner said.

"There's been a hint of it before, and it was more kind of the ratings agency giving them a kick to get their act together," he said.

Agencies would be hit along with Treasuries if the U.S. government rating is cut because Fannie Mae and Freddie Mac are backed by the government. But investors are not betting on a default yet.

"Ultimately I don't think anyone thinks the U.S. is going to default," Skinner said.

Fannie Mae sells three-years

Fannie Mae sold a sizable $5 billion of new 0.875% Benchmark Notes due 2014 at a spread of 28.5 bps over Treasuries.

The notes sold at 99.82 to yield 0.934%. Price talk was at a spread of 29 bps over Treasuries.

The notes went out the door at spreads of about 27.5 bps bid, 27 bps offered.

"There's been better buying in the issue all day," Skinner said.

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

The deal found a strong response from the market, evidenced by the fact that the deal amount was a significant upsizing from the $3 billion minimum for a benchmark issue and by the fact that price talk could be tightened.

"It was very, very well received," Skinner said. "They priced it such that it was attractive to outstanding issues."

The new notes offered a concession of about 1 bp to surrounding issues, which drew good interest from investors especially at current low yield levels.

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