Front-end agencies narrow on Fed support, focus on issuance; Fed eyes two- to four-years

By Kenneth Lim

Boston, Oct. 27 - Front-end agency spreads tightened slightly on Tuesday amid support from the Federal Reserve, with two- and three-year paper especially strong on the back of successful new issues.

"We continue to see GSE purchase operations by the Fed, which continues to be in the two- to three-year part of the curve," said Christopher White, senior vice president of fixed income sales and trading at Moors & Cabot Capital Markets.

Callable issuance continues to gallop at a brisk rate, he added.

"It's been very active in callable agencies," White said. "A lot of corporates are coming into the markets and buying the optionality in the market."

But volumes were thinner in bullets.

"I think it's because bullets are pretty tight right now," said White, noting that some off-the-run three-years were bid at a spread of about 38 bps.

Investors were also preoccupied with the Treasury markets, which are seeing almost $120 billion of auctions this week. Tuesday's two-year Treasury auction, in particular, was seen by many observers as being extremely successful.

"You've had a lot of issuance, obviously," White said. "You had the [Treasury Inflation-Protected Securities] yesterday and a very successful auction in twos today. Today's was probably the biggest success in twos recently. You have the fives tomorrow and then the sevens, so Treasury supply is where the fast money is right now."

The agency market has been relatively resilient in the face of the strong Treasury markets, White said.

"Usually you would think with the Treasury rally you'd see spreads widen out a bit in agencies," he said. "But agency debt right now is trading more in line with Treasuries. You don't see that widening on any credit concerns. As Treasuries rally, spreads would widen out a bit, you'd see that in corporates also, but we don't see that that much in agencies now."

FFCB sells three-years

Federal Farm Credit Banks Funding Corp.'s new 1.875% three-year Designated Notes tightened by about 5 bps to a spread of about 29 bps on their debut Tuesday.

The agency sold $1.5 billion of the notes in line with price talk at a spread of 34 bps. The notes were sold at 99.971 to yield 1.885%.

Banc of America Securities LLC, HSBC Securities (USA) Inc. and Morgan Stanley & Co. were the lead managers.

Details about the distribution of the offering were not available on Tuesday, but an FFCB spokesperson said most of the notes were sold to domestic investors.

White said the deal was "absolutely" a success and may have helped spreads at the short end of the curve to tighten.

"That's one of the reasons our bonds traded a little tighter today," he said.

The fact that an additional $1.5 billion of paper was added to the supply would not have hindered investors, he added.

"That's a drop in the bucket," White said. "There's so much money out there. We continue to see a swath of supply, and you continue to see the market absorb it with really no problem. As long as liquidity is in the system, you're going to continue to see cheap financing."

Fed to buy short-term agencies

The Fed, through the Federal Reserve Bank of New York, will buy agency paper due 2011 to 2013 on Wednesday, according to an announcement by the central bank.

Short-term on-the-run series have figured prominently in recent actions by the Fed, White noted.

"Most recently the largest purchases were the on-the-runs," he said.

The Fed last targeted the same sectors on Oct. 9, when it bought $2.573 billion of agency notes, which represents 45% of the notes offered.

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