Agencies tighten as market focuses on Fed purchase; new risk weighting pulls in TLGP spreads

By Kenneth Lim

Boston, Nov. 5 - Agency spreads closed slightly tighter on Thursday but remained wider a day after the Federal Reserve announced a surprise cut in the size of its outright coupon purchase program.

But as the Fed took, it also gave with an announcement that it will target four- to seven-year agency notes in its next purchase operation on Friday.

Agency notes backed by the Federal Deposit Insurance Corp.'s Temporary Liquidity Guarantee Program also tightened slightly after the federal guarantor lowered the risk weighting of debt issued under the program.

Bullet spreads made a small recovery from Wednesday, when the Fed's decision on the purchase program led to widening of about 4 to 7 basis points across the yield curve. On Thursday, spreads were seen about 1 bp tighter.

"It's not back to where it was, but definitely there were buyers who came in wide, which was the right thing to do," said agency trader Craig Ziegler of Broadpoint Capital.

Mark Noble, head of agency at MF Global, said five-year Fannie Mae benchmarks were marked at either side of 34 bps on Thursday, slightly tighter than the 35 bps spread on Wednesday. He believes the market is mostly done reacting to the Fed's announcement on the buybacks.

"Spreads are quite stable," he said.

Trading volume was thin as investors awaited Friday's economic numbers.

"Trading volumes today were really slow because we have payroll numbers tomorrow," Noble said. "But in general volume's been high. We've seen increased issuance of securities that they haven't been able to issue in a while like [Federal Home Loan Banks] TAPs."

Looking ahead, FHLB has an announcement on Global Notes slated for Thursday.

"Due to Libor they're probably going to be forced to the front end," Noble said.

Fed purchases in focus

All eyes will be on the Fed's purchase operation on Friday to discern how the market will handle the reduction and eventual phase-out of the quantitative easing program, Ziegler and Noble said.

"Tomorrow will be interesting to see how much was offered and bought back," Ziegler said.

The Fed on Friday will buy agency debt due 2013 to 2016 as part of its purchasing program. On Wednesday, the central bank said it will cut the program's size to $175 billion from "up to $200 billion," citing challenges in finding enough paper to buy.

Noble explained that the Fed announcement was especially surprising because the central bank did not really need to make a clarification on the program.

"Why did the Fed give up that option?" Noble said. "They made an announcement they didn't need to make now. They've always had the thing saying 'up to $200 billion,' not $200 billion. Why would you ever give up that option unless you needed to?"

He agreed that the operation will be "very scrutinized," adding that investors who had been waiting to offer their holdings to the Fed may now feel more urgency because the end of the program is near.

"Whatever holdings I have, are they going to hold on and say, 'Do I sell to the Fed now?'" he said. "That decision may be there now."

TLGP tightens with update

Spreads on notes issued under the TLGP also tightened on Thursday because of an update by FDIC that allows banks to risk weight the debt at zero instead of the previous 20%.

The move was done "after reviewing the legislative history of the U.S. government's full faith and credit backing of the FDIC," the guarantor said on its web site.

"FDIC paper's better today...the driver was talk about the 20% risk weighting," Ziegler said.

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