Agency spreads tighten ahead of next Fed buyback; two-year yields dip below Treasuries

By Kenneth Lim

Boston, July 30 - Front-end bullet agency spreads briefly dipped into the negative area on Thursday as the market readied for another round of buybacks from the Federal Reserve Bank of New York.

"Something interesting happened this morning," said Moors & Cabot Capital Markets senior vice president of fixed income sales and trading Christopher White. "Two-year agencies were trading inside of two-year Treasuries, which some of it was due to an arbitrage."

Three-year agencies were seen about 28 basis points over Treasuries, while five-years were around 24 bps over and the 10-years around 31 bps in the afternoon, White said.

"So it's a little bit tighter today."

But investors who looked at the Fannie Mae 1.375% notes due 2011 would have seen them about 1 bps through the Treasury curve, White said, "so people are paying more for the Fannie Mae April 2011s than 2-years [Treasuries]."

"It was just very brief," he said. "Right now the Home Loans 1.625% of July 2011 are 12 bps on top of Treasuries, so we've seen that trade that I told you about earlier today reverse a little bit."

White reckons that something is not right when agencies yield less than Treasuries.

"It's absurd," he said. "When you think that looking at agencies, they have this pseudo-explicit guarantee, trading tighter than the entity that guarantees them."

Fed to buy intermediates

The Fed announced its next round of open-market purchases for Friday, with agency securities due 2013, 2014, 2015 and 2016 being targeted.

The buybacks helped to boost agency spreads Thursday, said D.A. Davidson vice-president of fixed income trading Mary Ann Hurley.

"I would say they're a little tighter today...because the Fed is going to be doing an agency repurchase tomorrow," she said.

But agency investors were also watching the Treasury auction of seven-year notes to get a sense of demand, Hurley said.

"It was a good auction, and it was kind of unusual that the seven-years did better than two-years and five-years," she said. "I don't think it's really going to have that much of an impact on spreads, but certainly the longer part of the yield curve, meaning basically five-years and out is doing better. At the short end, the two-year area is still suffering some congestion."

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