Agency spreads narrow at front end; Fannie Mae reopens two-years; Fed purchases rumored

By Kenneth Lim

Boston, Nov. 18 - Agency spreads tightened slightly at the front end of the yield curve on Wednesday as bargain hunters saw value versus swaps and Treasuries.

There was also speculation that the Federal Reserve could announce another purchase operation because of the Thanksgiving-shortened week ahead.

Fannie Mae added $1 billion of supply in the two-year sector through a reopening of its two-year notes. The notes ended the day slightly wider.

Bullet spreads narrowed at the short end of the curve on Wednesday, but they stayed flat toward longer maturities, an agency trader said.

"Better buying in the front end," the trader said. "And out on the curve, on the day for the most part we saw a little bit of a widening in the seven- to 10-year areas but tightening in the front end. It's a steepening of the agency curve versus Treasuries."

The buying came from investors who were looking to take advantage of agencies' recent underperformance compared to Treasuries and swaps, the trader said.

"When the Fed said...that they're going to cut back the [agency purchase] program by $25 billion, we saw our spreads widen versus swaps, and it got to the point where relatively speaking values on a spread basis were attractive, so we actually saw better buying over the last couple of days," the trader said.

Volumes have been relatively light, and outright rate buyers, as opposed to spread buyers, have remained on the sideline.

"Everything's getting done on switch," the trader said.

Fannie Mae reopens two-years

Fannie Mae priced a $1 billion reopening of 1% two-year Benchmark Notes on Wednesday to yield 0.92%, according to a press release.

The notes were sold at 100.159. The spread was about 15 basis points over Treasuries, the trader said.

There is currently $5 billion outstanding under the series.

"They were basically trading at 17.5 basis points versus twos," the trader said. "They widened to close to 19 bps, and back to 17 bps, and they stopped at the auction at 15 bps fixed. It's now 16 to 18 bps...It's just $1 billion, and guys typically will pay through the screen levels just to show up for the auction. Generally it trades wider than where the auction comes."

The trader had been expecting a three-year deal or a pass. But a reopened deal in the two-year sector, even after Freddie Mac and Federal Home Loan Banks issued two-year notes earlier in the month, makes sense for issuers, the trader said.

"It's Libor flat to Libor positive further out on the curve," the trader said. Funding's the most opportunistic for them here," the trader said.

Investors also want shorter paper.

"That's the more defensive part of the curve," the trader said.

Fannie Mae also has two more possible issuance dates on the calendar for December, and not doing a bigger deal this month should not matter much, the trader added.

"They do have two more spots coming up in December," the trader said. "So reopening up today, they realize they have more opportunities later if funding improves."

Thoughts on holidays

The market on Wednesday also saw speculation that the Federal Reserve Bank of New York could announce a second purchase operation for the week, the trader said.

"There's talk that there could be one more buyback because they did it earlier this week and because of the holidays next week," the trader said. "I wouldn't be surprised if the Fed comes out tomorrow and announces another buyback for Friday."

The Fed on Tuesday bought $1.531 billion of seven- to 23-year agency notes. The amount of securities purchased was 35% of the $4.375 billion of notes tendered.

Beyond a potential boost from the Fed later in the week, the market expects some sluggishness in the next several days.

"The market's starting to look toward the holiday," the trader said.

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