=DJ US Agency Debt Mkt Vulnerable As Negatives Stack Up
07/08/2003
Dow Jones News Services
(Copyright © 2003 Dow Jones & Company, Inc.)
By Julie Haviv
Of DOW JONES NEWSWIRES
NEW YORK (Dow Jones)- The agency debt sector has been so far relatively unscathed by the recent shift out of Treasury securities into stocks by Japanese investors.
But the market is at a vulnerable point, say analysts, after its recent strong performance, particularly given its reliance on overseas buyers this year and the lower liquidity of the securities compared with Treasurys.
"Inflows from overseas investors might begin reversing," said Mukul Chadda, agency strategist at Lehman Brothers. "The recent backup in the Japanese bond market might prompt such a reversal."
In recent days, Japanese investors have been selling securities issued by government-sponsored enterprises Fannie Mae, Freddie Mac and the Federal Home Loan Banks, according to a source at a large Japanese-based firm.
The pressure on prices was offset by buying out of non-Japan Asia, but Tuesday's selling out of Asia was said to have outweighed the buying, he noted.
Japanese investors have been selling Treasury and agency bond holdings in recent sessions and moving into stocks. That shift comes as the Nikkei 225 stock average has inched ever closer to 10,000, closing Tuesday at an 11-month high at 9898.72.
This doesn't bode well for the agency market, which has benefited from Asian investors' hearty appetite for such debt this year.
In the first half of 2003, Asian buyers bought 33.9% of Fannie Mae's noncallable debt and about 24% of Freddie Mac's dollar-denominated debt.
And just two weeks ago, Asia bought a staggering 37% of the Federal Home Loan Banks' $3 billion five-year global debt offering.
And, apart from a brief interlude when the market was rattled by Freddie Mac's management shakeup and official probes into its accounting, the market has enjoyed an extremely good run in past months.
Agency yield margins over Treasurys - the premium demanded by investors for the additional risk associated with the bonds - are currently at their tightest levels in five years, and to some the sector offers little upside potential.
Lehman's Chadda noted that because trading volumes in the agency market are far lower than in the Treasurys market, price changes in the event of a sell-off would be far more pronounced in agencies than in Treasurys.
He said that the agency market has grown as a percentage of the Treasury market over the last few years, yet the average daily trading volume of agencies has not increased as much.
"If indexed funds were to alter their allocation of agencies, the impact on spreads would be greater now than earlier," he said.
Hunt For Yield A Negative, Supply A Positive
Some market participants are also keeping a close eye on domestic investors, who, in the current low interest rate environment, are reaching ever further for yield and turning to corporate debt.
"I think more important right now is domestic appetite for more corporates given the first half performance," said Jim Vogel, senior vice-president at FTN Financial Capital Markets in Memphis, Tenn. "While there might be a leveling off or slight decline in overseas appetite, I think the marginal buyer/seller to watch is domestic."
Vogel pointed to Tuesday's 10-year corporate offering from Goldman Sachs. The deal, originally launched with a size of $1.25 billion, was increased to $2 billion. It sold at 104 basis points over Treasurys, with a coupon of 4.75%. A basis point is 100th of a percentage point.
In comparison, the 4.50% Freddie Mac 10-year reference notes were quoted late afternoon at 36.6 basis points over Treasurys.
The agency market, however, does have positive supply issues working in its favor.
According to research by Shrikant Ramamurthy, agency strategist at RBS Greenwich Capital in Ct., net agency issuance declined by $15 billion in June as a result of strong call activity and buybacks. Net noncallable debt, or bullet, issuance declined by $27 billion in June.
Year-to-date net issuance has totaled a mere $14 billion compared with $115 billion in the first six months of 2002. Net bullet issuance in the first six months of 2003 has declined by a whopping $60 billion after an increase of $44 billion in the same period of 2002.
"Given the sharp drop in net agency supply...it is not surprising to find that agency spreads are close to their cyclical tights, despite the re-emergence of headline risks," Ramamurthy said.
By Julie Haviv, Dow Jones Newswires; 201-938-2071; julie.haviv@dowjones.com
(END) Dow Jones Newswires
07-08-03 1616ET
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