Agency spreads tighten as Fed supports front end; Freddie Mac could offer three-years: trader

By Kenneth Lim

Boston, Oct. 16 - Agency spreads tightened on Friday as the Federal Reserve's weekly purchase operation provided support at the front end of the yield curve.

Bullet spreads in the 10-year sector were about 1 basis point tighter, said Doug Matthius, an agency trader at Southwest Securities.

"Once again they're tightening," he said.

The new Federal Home Loan Banks 1.625% three-year Global Notes, which priced on Wednesday, were trading at a spread of around 0.5 bps near the close on Friday.

"That initially widened out to about 25.5 bps, now it's back to like 24 bps, kind of 0.5 bps tighter from where it came," he said.

Volumes were typically thin for a "ho hum, very boring" Friday, he said.

The next week will see a potential new issue from Freddie Mac, which has an announcement on Reference Notes slated for Monday.

"I'm expecting a new three-year," Matthius said. "That seems to be the talk on the Street."

Quiet week

The agency market had an exceptionally lackluster week, Matthius noted.

"Earlier in the week, we saw some overseas selling, some profit talking, but it's been an exceptionally quiet week," he said. "For a holiday shortened week, it was a very long week."

In terms of spreads, the week closed mostly flat.

"The 10-years were at 3.38%; now they're at 3.40%, so they're down only about 2 bps," Matthius said.

Investors did try to make the most of any declines, but the enthusiasm was still lacking, he added.

"We've had some ebbs and flows," Matthius said. "Every time you see the market dip, you see a lot of issuance. However, they're not cleaning up. There's still a lot of bonds left on the Street."

Investors appear to be waiting for better yields.

"I think customers are starting to get the feeling that true Treasury yields may start to break on the higher side, and some of these guys have got their hands in their pockets just waiting," he said.

Fed supports front end

The Fed on Friday bought $3.457 billion of one- to two-year agency notes through its outright coupon purchase program. The amount purchased was about 42.5% of the $8.139 billion of notes offered.

The purchases "lifted up" the targeted sectors, Matthius said.

"That's helped spreads in," he said. "I can't see how they can get tighter, but they seem to."

George Goncalves, chief fixed income rates strategist at Cantor Fitzgerald, noted that the Fed's bigger purchases on Friday came in the 2011 sector.

"Although the very front-end trades cheap in this sector, the Fed purchased chunkier sizes of individual names in the 2011 sector versus the cheaper 2010 bonds (contrary to what we expected)," he wrote in a note.

The size of the total operation and the fact that there were few sizable blocks of notes involved could be due to the fact that "a few folks came in with size offerings to the Fed," Goncalves wrote.

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