Agency spreads firm as Fed purchases give positive signals; FHLB could offer new two-years

By Kenneth Lim

Boston, Nov. 10 - Agency spreads tightened slightly on Tuesday as investors took comfort in the amount of notes tendered in a Federal Reserve Bank of New York purchase operation.

The market will return on Thursday with expectations that Federal Home Loan Banks could come to market with a two-year offering, market sources said.

Agency spreads were slightly narrower on Tuesday, said Thomas L. di Galoma, Guggenheim Partners head of U.S. fixed income rates trading.

"Spreads kind of nudged in today a little bit firmer," he said.

Debt that was issued under the Temporary Liquidity Guarantee Program outperformed agencies by about 1 to 2 basis points as the space continues to benefit from the Federal Deposit Insurance Corp.'s decision to reduce the risk weighting of such paper to zero from 20%. FDIC is the guarantor of TLGP notes.

"The zero percent risk weighting that has been talked about, that's moving TLGs," di Galoma said.

Positive buyback

The Fed on Tuesday bought $1.845 billion of one- to two-year agency notes as part of its outright agency coupon purchase program.

The amount was less than other recent actions in the sector, both in terms of notional amount and in terms of a percentage of notes offered. The amount purchased was about 35% of the $5.272 billion of notes offered.

But observers found the operation reassuring after the Fed said the week before that it was cutting the agency buying program to $175 billion from $200 billion.

"It went basically as expected," one trader said.

George Goncalves, chief fixed income rates strategist at Cantor Fitzgerald, noted that the amount of notes tendered was "more reasonable" than previous operations.

"This is a good sign for the agency market," he wrote in a note. "If this trend continues then investors are indeed taking the baton from the Fed and supporting the [government-sponsored enterprises] market."

Guy LeBas, fixed income strategist at Janney Montgomery Scott, said investors were looking for clues to "how the Fed buying transitions into a fully organic market and how smooth that transition is." In fact, the market had already hinted at its capacity to survive the ending of the quantitative easing program, he added.

"If you look at the market's reaction to the Fed announcement last week, it was very, very limited," he said. "That means the market was (A) anticipating that shift or (B) believes that it can take over from the Fed. I think it's a little of both."

FHLB could issue two-years

An agency trader said the Street was expecting FHLB to announce a new offering of two-year Global Notes on Thursday when the market returns from the Veterans Day holiday.

Guggenheim's di Galoma also expects an offering of two-year notes.

"We think they would like to do a five-year, but we bet that they'd probably do a two-year because of the richness in the sector," he said.

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