Agencies eke out modest gains on late buying amid volatility; Fannie Mae expected to skip

By Kenneth Lim

Boston, July 27 - Agency spreads managed to end in tighter territory Wednesday on a late wave of bargain hunting after a volatile session.

Bullet spreads closed the day about 1 basis point narrower versus Treasuries, said Mike Goldman, head of agency trading at Guggenheim Partners.

"Another volatile day today," he said.

The callable market remained muted, with the choppy markets and uncertainty about the stalled debt ceiling debate keeping money on the sidelines.

"Issuance continues, but I think it's been a little bit lighter," Goldman said.

Debt impasse lifts yields

Yields swung back higher on Wednesday as investors continued to grapple with the uncertainty surrounding Washington's stalemate over raising the debt ceiling and cutting the budget deficit.

The Treasury Department also had a weak auction of five-year notes, disappointing the market and raising questions about the strength of demand for U.S. government debt.

Democrats and Republicans continued to pursue rival strategies to avert a U.S. default or credit downgrade, with little indication that either plan would pass both chambers of Congress. The Treasury Department has said that the country will be at risk of default if the debt ceiling is not raised by Aug. 2, although economists have since noted that the country could have another week's worth of money to pay its obligations because of higher-than-expected tax receipts.

A default by the United States or a lack of a sound deficit-reduction plan could lead to a downgrade of the country's credit rating, rating agencies have also warned.

The lack of clarity over the situation has led to sharp back-and-forth movements in the market, exacerbated by light volumes.

"We started off pretty much unchanged, maybe a drop weaker and quiet," Goldman said. "Next thing you knew, out of nowhere it started going about 2 to 3 bps wider very quickly. Then it came back; then wider again - very little volumes, very volatile and thin."

The midday softness nevertheless seemed to draw some bargain hunters back into the fray.

"The only thing that felt like a retail move was the last move tighter," Goldman said.

Fannie Mae could skip

The market is not expecting Fannie Mae to bring a deal on Thursday when it makes an announcement on Benchmark Notes issuance.

The agency sold $5 billion of new three-year notes just two weeks ago, on July 14, and Fannie Mae's shrinking need for funding suggests that it will not come to market again this round.

Funding costs are also on the richer end at the moment.

"I expect a pass...it's not attractive funding levels," Goldman said.

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