Agencies widen amid Europe concerns, flight to Treasuries; Freddie Mac forgoes issuance

By Kenneth Lim

Boston, Aug. 2 - Agency spreads widened Tuesday on the back of weak consumer spending numbers and concerns about Italy and Spain, while Freddie Mac skipped an issuance date.

Bullet spreads underperformed versus Treasuries on the day as investors initially fled for safe-haven assets following the day's weak economic numbers. The five-year spread ended the day about 35 basis points over Treasuries.

"There's no shortage of bad news here," an agency trader said.

The callable market also remained quiet because of uncertainty about where the United States' credit rating will be after the rating agencies are done analyzing the new debt reduction bill. Fitch Ratings has said it will not downgrade the United States for now, while Moody's Investors Service confirmed the U.S. Aaa debt rating and assigned a negative outlook. Standard & Poor's had not commented by press time.

"Callable demand has been very high, but issuance has been very slow," the trader said. "As people try to figure out what the debt ceiling needs are, there's a little bit of uncertainty there.

Yields reach recent lows

Yields fell across the board Tuesday on an avalanche of news.

On the economic front, consumer spending dipped by 0.2% in June, the first time consumers have cut back since September 2009.

"People are focused on an economic double dip," the trader said.

A flight to quality also found support across the Atlantic, where borrowing rates for Italy and Spain continued to rise, stoking new concerns about those countries' ability to continue borrowing money from the capital markets.

The U.S. Senate passed a debt reduction bill into law on Tuesday, averting a default by the United States and laying out a plan to cut the country's budget deficit.

"We obviously got the debt ceiling passed, but that didn't really calm down the market except for the bill market at the very front end," the trader said.

Although a default had been averted, investors were still worried that the United States could lose its Aaa credit rating. If the U.S. credit rating is downgraded, credit ratings for the agencies, which are backed by the government, will also be hit.

"The other thing that was kind of spooking the market was the potential for downgrade for GSEs, which I think is certainly possible," the trader said. "I think it will be a bad event, but not as bad an event if the government was not downgraded as well...I think agencies will widen on that for sure, but I think it will eventually snap back."

One cause for optimism was that the selling that characterized the morning gave way to bargain hunting in the afternoon.

"The agency space was better selling in the morning; in the afternoon it was better buying," the trader said. "The rally [in Treasuries] has really stoked interest in spread products. With the two-year note at 32 cents, anything above that will be appealing to people."

Freddie Mac passes

Freddie Mac said Tuesday that it would not use a calendar opening to issue new Reference Notes.

The agency's next issuance slot is on Aug. 25.

Investors were not surprised that Freddie Mac passed, given that it took care of quite a bit of its funding needs in July. The current uncertainty about the agency's credit rating may also make it difficult to price new issues.

"They did two successive issues very quickly in July," the trader said. "I don't expect them to come with anything this round."

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