Agencies fall behind Treasuries as worries over Greek default set off panic; yields drop

By Kenneth Lim

Boston, Sept. 9 - Agency spreads widened Friday as fears of a Greek default sent investors ducking for cover behind the safety of Treasuries.

Bullet spreads went out about 1 basis point to 3 bps wider versus Treasuries across the yield curve, with the belly of the curve seeing a stronger degree of underperformance. Two-year spreads were about 1 bp to 2 bps out versus Treasuries, while five-year spreads were about 3 bps wider.

Agencies outperformed swaps, however, which was not a surprise given the sovereign credit issues underpinning Friday's moves. Swap spreads were out by about 3 bps to 4 bps.

"It's definitely got a government credit Libor thing going on," one desk analyst said.

Trading volumes, however, were light amid the market's nervousness and the coming weekend.

"I got a feeling the flows aren't too heavy and they're just small sizes, just people making markets," the analyst said.

Greek default fears escalate

Investors were spooked Friday by the surprise resignation of European Central Bank board member Jürgen Stark.

The departure of Stark, who was opposed to the ECB's policy of buying Greek, Italian and Spanish bonds to ease pressure on those countries amid a debt crisis, fueled speculation about divisions within the ECB that could hinder efforts to stave off a default by a peripheral economy. Greece is widely viewed as the most vulnerable country in the euro zone, and the credit default swaps on Friday seemed to price in a possible default over the weekend.

Greek Prime Minister George Papandreou was scheduled to address those concerns and rebut speculation about a default after the markets closed.

"Obviously there was a lot of fear today," the analyst said.

While a number of analysts have opined that a weekend default was not likely to happen, "the market is definitely on to something, but I don't know exactly what," the analyst said.

Yields fell sharply on Friday, with the 10-year Treasury yield closing at an all-time low of 1.92%.

The analyst reckoned that the market may have been feeding on its own fear and panic, overreacting to the smallest piece of news. For instance, the market reacted strongly to a snippet of a "a very casual e-mail saying something like maybe [Greece] could default this weekend," the analyst said.

"There are so many rumors," the analyst said. "It shows you that something needs to be done, not just in Europe, but it's clear the market is really panicking on its own noise."

Contagion fears

The analyst, who does not look specifically at Europe, nevertheless thought that the market may have been overreacting on Friday, which suggested that yields could back up and spreads could come back in on Monday if no negative news emerges over the weekend.

But a negative development out of Europe, like a default, would trigger a run for Treasuries.

"If something happens, it's probably going to be an outperformance of Treasuries versus everything else," the analyst said, "because that would be the beginning of a potentially very big event, and that's the kind of situation where agencies kind of hang around with swaps and swap spreads go out to 50 bps real fast.

"Because I think once that first spark lights, the market's going to panic about Italy and Spain and so on and that's going to be a tremendous move."

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