Agency spreads narrow as Fed buys two- to four-year notes; callable issuance to stay strong

By Kenneth Lim

Boston, Dec. 18 - Agency spreads tightened slightly on Friday as the Federal Reserve Bank of New York provided support at the short end of the yield curve.

Bullet spreads were about 1 to 2 basis points tighter across the curve, with slightly more narrowing near the front end, an agency trader said.

"Spreads were tighter across the curve due to government buying," the trader said. "Other than that, it's been pretty quiet."

Trading volumes were lackluster, although the morning was more active than the afternoon.

"All in all [it was] a pretty quiet day going into holiday week next week," the trader said. "We were pretty active in the morning, but in the afternoon it kind of died down."

The coming week will be even slower.

"I wouldn't expect a lot of big deals," the trader said.

Callables march on

Callable issuance remained active, and the strong issuance volumes should continue until the end of the year even if secondary trading drops to a whisper, the trader said.

"People will just roll the settlement into January and start doing it then," the trader said.

The robust callable pipeline is a result of the agencies, especially Federal Home Loan Banks, having substantial short-term debt rolling off, the trader said.

"Granted there's not a lot of funding going on," the trader said. "However they still have a lot of funding needs in terms of funding older liabilities in their books. The agencies in the last 1.5 to 2 years have been funding themselves with short-term debt...because it was beneficial to them."

The new callable deals will simply be settled in January to allow for the holiday slowdown.

"People will just do January settlements," the trader said. "It won't slow down that much. You won't see 60 issues a day, but you'll still see 20 to 25 a day."

Fed buys front-end notes

The Fed on Friday bought $1.704 billion of agency notes due December 2011 to December 2013 as part of its outright coupon purchase program.

The central bank received $5.682 billion in tenders, implying an acceptance rate of about 30%.

"That's about average as of late," the trader said. "That's right in line with how much they've been buying. There's really nothing to read into that."

The size of the purchases will probably continue to decrease in 2010 as the Fed tapers the final lap of the program, which will end by March 31, 2010.

"They're almost done with the program with agencies," the trader said. "They're going to max out in March."

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