Agency spreads tighten on Treasury weakness, Fed support; Fannie Mae new two-year narrows

By Kenneth Lim

Boston, Oct. 8 - Agency spreads made a firm move inwards on Thursday as investors switched away from Treasuries and the Federal Reserve provided support at the shorter end of the yield curve.

Fannie Mae sold $5 billion of new two-year Benchmark Notes, which saw their spreads narrow over the day.

Bullet agency spreads tightened by about 1 to 3 basis points across the board on Thursday, an agency trader said.

"The tone of the market today was much better, especially after yesterday when we widened out a little bit," the trader said. "I think it was just good bids in mortgages and in the swap market. Spread products in general were doing better. You'll see that in general when Treasuries trade off."

The trader welcomed the change.

"This is the first day in the last five or six that we've actually seen a pretty good tone on the market," the trader said.

The performance of the Treasury market on Friday will be a key factor in how agencies end the week, the trader added.

"If we were to get the Treasury market trading down again tomorrow ahead of the weekend, I'd expect spreads to tighten further," the trader said.

Investors had been waiting on the sidelines for yields to become more attractive, the trader explained.

"Clients want to buy paper, but they want to do it at a higher yield," the trader said. "I had clients who wanted 10-years, but they want it at or behind 4%, but I'm offering it at 3.96%, 3.97%, so we only need a little bit more."

Corporate earnings could help to bring yields higher if equities become more attractive.

"We're just starting earnings season in equities, and if that's pretty good, if we have another chance to break 10,000 [in the Dow], we could see yield improve," the trader said.

New Fannie Mae tightens

Fannie Mae's new 2% Benchmark Notes due 2011 tightened by about 4 bps on their debut Thursday, ending with a spread of about 20 bps.

The notes priced with a spread of 24 bps over Treasuries. The notes were sold at 99.758 for a yield of 1.116%. Price talk was at a spread of 24 bps.

Banc of America Securities LLC, Citigroup Global Markets Inc. and J.P. Morgan & Co. were the lead managers.

The deal was oversubscribed, with bids for about $7 billion of notes, the trader said.

"It definitely got a very good reception," the trader said. "It was too cheap to start, and when the Fed announced the buyback and the market saw that the deal did really well, it was priced to move and it moved."

Fund managers took 61.6% of the offering, according to data from Fannie Mae. Central banks had the next largest chunk, 23.4%, while state and local governments bought 6.1%.

Domestic investors were the largest group of buyers, mopping up 73.5% of the offering, followed by Asian investors with 20.1% and European investors with 2.2%.

Fed to buy at short end

The Federal Reserve Bank of New York also did its part to support the market on Thursday, announcing that it will buy two- to four-year agency paper before the weekend.

The Fed's weekly operation will target agency notes due 2011 to 2013 on Friday, the central bank stated.

"It's not a surprise to me that they were going to buy back in that sector, but it definitely got the market moving today," said the trader, who reckoned that spreads in the three-year sector may have tightened by about 1 bps because of the announcement.

The Fed has bought $133.8 billion of agency paper under the program, which is slated to end at the end of the first quarter of 2010.

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