US Agency Spreads Wider, Risk-Takers Pull in Horns

July 29, 2003
By Lynn Adler

NEW YORK, (Reuters) - Asian selling overnight and an unwillingness to buy on dips or add to risk exposure battered U.S. agency debt for the second straight day on Tuesday.

Agencies sharply underperformed ailing Treasuries, even as 10-year Treasury note yields surged to peaks unseen in nearly a year. Mortgage-related selling quickly stomped out a rebound attempt in Treasuries and agencies, forcing both sectors to finished near session lows.

"There's a lot of pain out there," said Sean Horrigan, vice president of government agency trading at Legg Mason Wood Walker in Baltimore.

"Everyone is pulling in their horns," he added. "There's not a lot of risk-taking right now. Everything is getting crushed. There's nowhere to hide. Swaps are getting crushed, Treasuries crushed - they've taken everyone out to the woodshed."

Agency yield spreads leaped as much as six basis points on Tuesday, losing ground from the outset after Asian investors sold overnight.

Market players had feared Asian investors would turn sellers on recent reports that the European Central Bank was dumping agencies and advising other euro zone central banks to sell as well. Asian accounts are larger holders of U.S. agencies than Europeans.

"The Street was hoping Asian central banks would bail out the widening and show up and buy like they have in the past, and last night instead they sold, so it kind of put the hex on the market and caused some more widening," said Woody Garavente, vice president of agency trading at Nomura Securities International in New York.

Asian investors are unlikely to be "wholesale sellers," he added.

Tuesday afternoon, Euro zone central bank sources dismissed long-running market rumors the ECB had issued a health warning on U.S. agency debt or advised euro zone national central banks to cut their exposure, Reuters reported.

Agency spreads did narrow slightly from their widest levels before this report, in sympathy with a short-lived bounce in Treasuries. But the report failed to lift the market, and spreads expanded again as Treasuries faded to new session lows.

"People are so beat up and battered that a couple of trades are not going to lift this market up," Horrigan said after the Reuters ECB story. "There's no conviction right now in this market."

The spread jump on Tuesday follows a similar move on Monday.

In one example of the recent sour market performance, Freddie Mac 10-year notes sold on July 16 at a 46 basis-point spread have since swept out to a 63 basis-point offered spread.

Agencies have been under a cloud since Freddie Mac swept out top management in early June and its accounting methods drew federal scrutiny amid an earnings restatement.

"It may just be that we need to find the levels where other people decide foreigners care about agency debt," Garavente aid. "I'm not looking for a massive widening from here."

(Additional reporting by Nancy Leinfuss)

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