Agency spreads tighten as Fed purchase reassures; demand still strong for new supply: trader

By Kenneth Lim

Boston, Nov. 6 - Agency spreads tightened slightly on Friday as the Federal Reserve Bank of New York provided some support at the belly of the yield curve.

Bullet spreads were about 1 basis point narrower across the curve, an agency trader said.

"I think all in all the buybacks, coupled with a little bit of volatility bleed, that's helped...bring spreads in about 1 to 1.5 bps across all sectors," the trader said.

Spreads remain wider than before the Federal Open Market Committee earlier in the week said it would cut the agency coupon purchase program to $175 billion from $200 billion.

"We're within about 1 to 2 bps from that," the trader said. "We pushed out especially on the long end when the FOMC announcement came out, pushed out 5 to 7 bps, and we've come in a little. I have benchmarks in the 10-years at about 30 to 34 bps before and now they're at 34 to 37 bps."

The main effect of the cutback was steepening the curve, the trader said.

"The shape of the curve changed too; we had the curve steepen out," the trader said.

Volumes were noticeably thin, said Michael Skinner, an agency trader at Wall Street Access.

"Today has been pretty quiet," he said. "We're kind of following the pattern of recent weeks. I guess most of the people need a breather."

Agency spreads have actually held rather well given the FOMC announcement and could be range bound for the rest of the year, Skinner said.

"I think all bets are off in 2010, but from now till the end of the year we should stay in the range," he said.

Fed supports five-years

The Fed on Friday bought $2.714 billion of four- to seven-year agency notes, or 42.5% of the $6.389 billion tendered.

The operation was the first after the Fed said it would cut the size of the program to $175 billion from "up to $200 billion." There is about $25 billion remaining in the program.

Skinner said investors who were looking to see if the cutback would effect the Fed's buying decisions found a pretty normal operation.

"Guys were trying to trying to figure out how much is left and how aggressive they're going to be," he said. "Actually they were pretty in line with where they were doing stuff."

The winding down of the program will probably not stir the market too much, he added.

"They're not going to just stop cold turkey," Skinner said. "Maybe the next time they'll take 40%, but they're going to gradually wind this down. The government has tried to provide order in the market. They're not going to do anything crazy."

The other agency trader said the effect of the buybacks, which have helped to keep spreads tight, will also be diminishing.

"I don't know how much more news the buyback is going to be able to carry going into March," the trader said. "They've scaled it back. I think that news is going to be waning. I think if they hadn't said anything it would have more credence to it; people would have been like, they may raise it, but now they've cut it down to $175 billion so that's not as much of a possibility anymore."

Persistent demand

The trader said the market should have no trouble absorbing additional supply coming up.

Federal Home Loan Banks has an announcement on Global Notes slated for Nov. 12, while Freddie Mac is on the calendar for an announcement on Nov. 16.

"Given where overall rates are, especially at the long end, we think the supply's going to be digested fairly well," the trader said. "It's not like 10s are at 3.25%. Now they're around 3.44%, so based on where rates are currently, I think it should go pretty well."

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