Agency spreads flat as Fed targets five-year area; Fannie Mae new two-year notes unchanged

By Kenneth Lim

Boston, Dec. 3 - Agency spreads were flat on Thursday, with the belly of the yield curve tightening slightly as the Federal Reserve Bank of New York announced a purchase operation around the five-year sector.

Fannie Mae priced $3 billion of new two-year notes at a slight concession, and the paper ended mostly unchanged from its initial spread.

Bullet spreads were mostly unchanged on Thursday, although the five year seemed to perform a little better on the Fed announcement, said Wall Street Access agency trader Michael Skinner.

"The Fed announced the buyback, December '13s to April '16s," Skinner said. 'They tightened a little bit there."

Demand for callable step-ups remained strong following busy issuance days on Tuesday and Wednesday. Investors like the higher-than-money-market returns and the potential for better yields if interest rates rise, Skinner said.

"A lot of people still like that story," Skinner said.

Temporary Liquidity Guarantee Program notes were quieter than previous weeks amid a lack of buying interest, he added.

"I haven't seen a whole lot of action in TLGPs," he said. "Spreads have kind of wallowed."

Fannie Mae flat on debut

Fannie Mae's new 0.875% two-year Benchmark Notes closed their first day of secondary trading unchanged at a spread of 25 bps.

The $3 billion deal sold at a spread of 25 bps over Treasuries. The notes priced at 99.79 to yield 0.976%. Price talk was at a spread of 24.5 bps over Treasuries.

Citigroup Global Markets Inc., J.P. Morgan Securities Inc. and Morgan Stanley & Co. were the lead managers.

"They initially tightened by about a point," said Skinner, who added that the deal arrived at a concession of about 2 bps.

"It's not ridiculously cheap, but it was fair," he said. "It came where it was supposed to come."

Domestic investors bought 73.7% of the notes offered, according to data from Fannie Mae. Asian investors received 14.8% of the deal, while 2.7% went to investors in Europe.

Fund managers were the largest investor class, taking 60.8% of the offering. Central banks bought 18.1%, while commercial banks bought 12.4%.

Fed targets five-years

The Fed announced that it will buy four- to seven-year agency notes on Friday as part of its outright agency coupon purchase program.

The market was not too surprised that the Fed decided to visit the sector this week. Its past three operations have been in the two- to four-year, seven-year and out, and one- and two-year sectors.

"I think that was pretty much expected," Skinner said. "They were pretty much due for that part of the curve."

Window dressing

Trading volumes have thinned out from the previous week because of the typical year-end slowdown, Skinner said.

"A lot of guys are in year-end type mode," he said. "You might see some window dressing here and there, but things have certainly quieted down."

Over the week, the further end of the curve has outperformed, which is expected given that most of the supply coming from the agencies has been at the front end, Skinner said. The flattening curve could be good news.

"That's what the Fed has wanted them to do from the get go," he said. "You want to force things out of the discount notes, the bills, getting them further out on the curve."

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