Agencies widen as FDIC rules spark richening in Treasuries; Freddie Mac three-years eyed

By Kenneth Lim

Boston, April 4 - Agency spreads widened on Monday after new Federal Deposit Insurance Corp. charges led to a sharp drop in front-end Treasury rates.

Market sources also cited anticipation of possible supply from Freddie Mac on Tuesday as a source of widening, especially in the three-year sector.

Bullet spreads in general closed the day about half a basis point further out from Treasuries, ending off of the day's wides as investors recovered from the initial shock of the morning's widening of about 1 bp.

"The big news of the day was the new FDIC charges, which caused repo rates to fall," said Craig Ziegler, a trader at Gleacher & Co.

The callable market had an unremarkable session, with smaller deals dominating the screens. The largest deal was a $100 million offering of three-year, non-callable two years notes, Ziegler said. The bulk of new issues were in the $10 million to $25 million range.

There were no large deals done on Monday, Ziegler said, noting that "most of the activity remains in five-years and under."

FDIC charges hit spreads

Front-end rates fell sharply on Monday after the FDIC this month enlarged the assessment base for banks' deposit insurance rates. The new system severely cut into any arbitrage that banks used to be able to get by lending to the Federal Reserve.

Because the new charges took away the incentive for banks to carry out the trade, supply dried up in the repo market, especially at the front end of the yield curve. Repo rates turned negative on Monday at the front end, affecting rates and swaps across fixed income markets.

In agencies, three-year spreads bore the brunt of the widening.

"As Treasuries richened, the whole sector widened about 2 bps on the day," Ziegler said. "It's more a repo play. Three-year agencies went out plus 10 bps on Friday, and they're plus 12 bps today."

The widening pressure should ease if Treasury supply recovers, Ziegler said. At the very least, that should happen after the Federal Reserve stops buying Treasuries on the open market as part of its current quantitative easing program.

"If these loosen up, these things will tighten back," Ziegler said.

Freddie Mac in pipeline

Freddie Mac is widely expected to announce an offering of Reference Notes as part of a calendar announcement on Tuesday, Ziegler said.

"If Freddie Mac doesn't come through, if Freddie Mac passes tomorrow, if you remember what happened when Fannie Mae passed [on March 24], the market would definitely tighten in," he said. "It goes along with the idea of less supply."

Agency investors have been starving for new benchmark supply for about a month, with the last large-sized issuance coming from Fannie Mae on March 2. If Freddie Mac passes on Tuesday, the next calendar announcement will be a week later from Federal Home Loan Banks.

But the market is betting on a three- or five-year offering, with more money betting on a three-year offering, Ziegler said.

In fact, when three-year spreads widened out early Monday, it crossed his mind that the market could have been setting up for anticipated supply. But the trader said that as the day went on it became apparent that the FDIC charges played a bigger role in the day's widening.

Ziegler does not expect Freddie Mac to skip on Tuesday.

"The levels are attractive enough," he said.

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