Agencies widen as European ministers resist Geithner; all eyes on FOMC meeting, supply ahead

By Kenneth Lim

Boston, Sept. 16 - Agency spreads widened slightly on Friday as concerns about Europe's debt crisis heading into the weekend led to a pullback from the week's confidence march.

Bullet spreads closed the day flat to about 1 basis point wider versus Treasuries, moving in sympathy with swaps. Trading volumes, however, were muted.

"Not a heck of a lot going on," an agency trader said. "Folks are kind of counting the minutes to the weekend."

The callable market took the opportunity to move some inventory following a robust week for callable issuance.

"A large volume of short callables left the Street yesterday and today, and guys are just continuing to clean up deals that have been sitting on their books for the last couple of days," the trader said.

Europe fears return

After a week of tightening on the back of declining Treasury prices, spreads eased out again Friday as investors shifted back into safe haven assets ahead of the weekend.

"It was kind of a stealth rally in Treasuries," the trader said. "It was just kind of a grinding bid. Stocks are up, and you'd expect Treasuries to be down, but it looks like with all the uncertainty coming out of Europe nobody wants to go into the weekend short."

At a meeting of eurozone finance ministers in Poland on Friday, U.S. Treasury secretary Timothy Geithner urged members of the currency bloc to be more aggressive and coordinated in introducing stimulus, easing liquidity and assuring markets about Europe's debt crisis.

But investors were discouraged after Eurogroup president Jean-Claude Juncker said governments in Europe had no room to pursue more stimulus. There also appeared to be resistance to Geithner's proposal to increase the size of bailout funds.

The outcome of Friday's meeting raised concerns about the ability of Europe's governments to address the crisis that has left Greece tottering at the brink of default.

"We're steeper today," the trader said. "How that translates into agencies is there was a little bit of a lag move today. The grinding bid in Treasuries conversely widened swaps a little bit and took agencies out with it."

Fed meeting in focus

Investors will return on Monday to a supply announcement by Fannie Mae, which will also have another calendar slot just three days later.

One analyst said noted that Fannie Mae has passed quite often, and its funding needs have been reduced, suggesting that the agency may not have to use both dates.

Investors will also be keenly watching the Federal Open Market Committee's two-day meeting, which ends Thursday. The Fed widely expected to announce some sort of policy action to flatten the yield curve by acquiring long-end Treasuries.

But expectations on the details are far ranging. The Fed could increase its portfolio and buy long-end Treasuries, or it could simply reinvest proceeds from its existing holdings of shorter paper into longer ones. The central bank could also reduce interest paid on excess reserves that banks hold, or simply not do anything.

The impact on agencies will largely depend on how well investors turn out to be at predicting the Fed's decision.

"It's just a question of how much has been priced in," the trader said. "If they announce they're going to go forward, you would expect short agency spreads to tighten and long agency spreads to widen."

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