Agency spreads tighten versus swaps to end week; Fed lends support with $2.6 billion action

By Kenneth Lim

Boston, Oct. 9 - Agency spreads ended Friday relatively flat against Treasuries but outperformed swaps as buying from the Federal Reserve Bank of New York buoyed the market.

Bullet spreads were unchanged versus Treasuries on Friday, an agency trader said.

"We didn't necessarily tighten that much versus Treasuries, but we did outperform swaps today by 3 basis points at least at the front end of the curve and a good 3 bps out on the 10s, so it was fairly consistent."

The week ended on a positive note for the market.

"It's been a strong week in general for both agencies and FDIC paper," said the trader, referring to debt guaranteed by the Federal Deposit Insurance Corp. under the Temporary Liquidity Guarantee Program. "There was a lot of FDIC paper being traded due to talk about reducing the risk weighting for those who hold it."

The agency curve flattened slightly relative to the Treasury curve during the week as the Treasury curve steepened while most of the action in agencies was at the belly of the curve, the trader noted.

"There's a little flattening tendency in general when accounts get pushed out on the curve," the trader said.

Volumes in general were thin with the bond markets closed on Monday.

"It was a pretty quiet day," the trader said. "However we did have some buying in the sectors that the [Fed] buyback was conducted at."

Fed support

The Fed on Friday bought $2.573 billion of agency paper as part of its open-market purchasing program, or about 45% of the notes offered.

The targeted notes mature from 2011 to 2013.

The Fed action helped to spur tightening in the newly issued Fannie Mae 1% Benchmark Notes due November 2011, which closed on Friday at a bid spread of about 21 bps. The deal priced at a spread of 24 bps.

"Those tightened as much as 5 bps, not in small part because they were included in the buyback today," the trader said. "That was essentially a blow-out deal, since they hadn't printed any since April."

George Goncalves, chief fixed income rates strategist at Cantor Fitzgerald, said the latest operation was slightly smaller than expected. The Fed has said it plans to taper its buying as the program comes to a close at the end of the first quarter of 2010, although Goncalves stopped short of declaring Friday's action as a sign of smaller purchases to come.

"But it definitely keeps the market on its toes," he wrote in a note. "Less buying of securities would not only help reduce excess reserves (which at some point need to be drained) but would... lessen the impact on liquidity in the GSE sector."

FHLB in the pipeline

The week ahead could see Federal Home Loan Banks issuing a new deal. An announcement is expected Tuesday.

"If they do a new issue, they just did a three-year recently, but I still don't think they're going to venture out to the belly of the curve, so I think they'll continue to do something at the short end of the curve," the trader said.

The trader noted that an FHLB deal could face marginal competition from the agency's own TAP issue program, which has accelerated in recent months. But FHLB also tends to slow TAP issuance when a new global bullets issuance is in the pipeline, the trader added.

A bigger factor in how well an FHLB deal will perform would be where yields are headed, the trader said.

"If we continue to soften up, if we go past 1% on two-years as opposed to the 0.875s now, you have a much better chance of a Home Loans deal getting well-received," the trader said. "There's a lot of money out there looking to buy."

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