Agency spreads mixed amid calmer markets, but new Fannie Mae deal pushes out front end

By Kenneth Lim

Boston, June 2 - Agency spreads ended mixed on Wednesday, with the belly of the yield curve outperforming other sectors amid a drop in volatility.

Fannie Mae announced an offering of new two-year Benchmark Notes, which caused some widening at the front end, but the deal is expected to do well when it prices Thursday.

Two- and three-year bullet spreads eased out slightly, while spreads in the five- to seven-year sectors tightened by 1 basis point, an agency trader said. Further out on the curve, spreads closed flat.

There was "good buying in the one-year, good buying in fives to sevens," the trader said. "[Medium-term notes] have been widening; they just stopped widening today."

The trader noted seeing "more interest in off-the-run stuff."

Callable trading was brisk as investors continued to seek defensive positions.

"A lot of guys were calling out of callable pieces, so they're trying to put that money back to work," the trader said. "It's pretty defensive kind of stuff, not really putting new money into the market, just money that's been called."

Overall trading volumes were better than average.

"It was pretty busy today," the trader said, noting the pace was "slightly above average for what you'd normally see on a summer day."

Spreads find relief

The market seemed to be more comfortable with taking on risk on Wednesday as equities and spread products saw prices rise steadily over the day.

"Volatility was off today," the trader said. "Equity volatility was down. Fixed income volatility was down. When we get a reduction in volatility, guys come back to spread products."

Part of Wednesday's comfort came from widespread expectations that jobs data to be released on Friday will reflect strong improvements on the domestic employment front. A stronger economy would reduce aversion to spread products such as agencies.

"It's anticipation of pretty good jobs numbers on Friday," the trader said. "The market doesn't have to get better for spreads to come back in. It just has to not get worse."

Fannie Mae launches two-years

Fannie Mae plans to price new two-year Benchmark Notes on Thursday, talked at a spread of 31 bps over Treasuries.

The size of the deal has not been set, but it is expected to be at least $3 billion.

Banc of America Securities LLC, Goldman Sachs & Co. and UBS Securities LLC are the lead managers.

The announcement of the deal led to Wednesday's widening in the two- and three-year sectors, the trader said. At 31 bps over Treasuries, the new notes will be about 2 bps wider than existing July 2012 bullets, the trader added.

"It's fair given where new issues have been coming," the trader said. "Anything 5 bps wider is too cheap and prices really well. 2 bps over is middle of the range, but it will do well."

Investors appear prepared to buy up the new supply.

"There's definitely demand for the paper," the trader said. "I'm seeing guys swapping against it, selling existing paper to buy the new ones."

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