Agency spreads expand as market pauses after rally; Fed meets expectations with purchase

By Kenneth Lim

Boston, Jan. 7 - Agency spreads widened slightly on Thursday as investors took a break from the recent market rally, while the Federal Reserve Bank of New York's first outright purchase of the year ended in line with expectations.

Spreads were a couple of basis points wider on the day, said RBS Securities' head of agency trading, Scott Graham.

"Agencies cheapened up a touch," he said. "We had some supply this week from Freddie Mac, which was very well received. We've seen some mixed flows."

He noted that overseas accounts had been active buyers in the market, easing fears in 2009 that foreign central banks would shift away from agencies to safer Treasuries because of uncertainty about the health and the future of the government-sponsored enterprises. But the U.S. Treasury on Dec. 24 pledged its full support for Fannie Mae and Freddie Mac, and "we've seen a marked difference in their appetite," Graham said.

But domestic accounts were less enthusiastic on Thursday after the market's recent richening.

"We've seen some selling from U.S. accounts," Graham said. "I think overall people are not willing to jump in full board right now."

Another agency trader said investors were taking profit ahead of Friday's non-farm payrolls data and waiting to see if they should return.

"I think we were due for a correction," the trader said. "We've been tightening every day since the Treasury announcement. I guess with non-farm payrolls coming out tomorrow, it was a pretty good time to take some profit and wait to see what happens."

Fed buys at long end

The Fed on Thursday bought $950 million of agency notes due July 2016 to July 2032 as part of its outright agency coupon purchase program.

The amount purchased was 30% of the $3.169 billion of notes offered.

The central bank has bought about $160 billion of agency paper as part of the $175 billion program, which ends on March 31.

Graham said the Fed operation on Thursday "helped to clean up some supply."

But the other trader said the acceptance rate was in line with the previous operation and did not surprise the market. The Fed remains the biggest buyer in the market, but the impact of the operations are now marginal, the trader added.

"In terms of the actual buying, it's not a very big deal right now," the trader said. "I think the Treasury announcement is doing more for spreads now than the Fed coming to buy every week. That's because everyone knows the buybacks are going to end in a couple of months and the amount that they buy is getting less and less. They bought 30% this time, but even if they bought 25%, so what? They're already priced in."

The bigger impact of the Fed's buybacks lies in the central bank's holdings.

"They've bought up all these securities, and in all likelihood they're going to just let them run out when they mature instead of selling back to the market eventually," the trader said. "But the fact is they're holding so much that it's affecting liquidity, and supply isn't really matching the amount of demand right now.

"It's great for spreads, but it affects how much interest there is in the product."

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