Front-end agencies tighten as Fed targets five-year sector; new Fannie Maes tighten on debut

By Kenneth Lim

Boston, Aug. 13 - Agency spreads tightened at the front end despite new Fannie Mae supply on Thursday after the Federal Reserve said it would buy four- to seven-year paper.

Bullet spreads were 1 to 2 basis points tighter in the two- to five-year sectors of the yield curve. But spreads eased out by 0.5 to 1 basis point further out on the curve.

The Federal Home Loan Banks 1.625% notes due July 2011 saw its spread narrow by 2.7 bps to 14.6 bps. Freddie Mac's 2.125% notes due September 2012 tightened by 2.2 bps to a 34 bps spread, while its 3% notes due July 2014 were 2.5 bps narrower at a 35 bps spread. The Freddie Mac 3.75% notes due March 2019 widened by 0.8 bps to a 38 bps spread.

"Spreads tightened a little bit," one broker said. "It was just listless trading...kind of moving with the equity markets."

An agency trader noted that five-year spreads had actually widened early in the day.

"The Fed came in after the bond auction and announced they're buying five-year agencies," the trader said. "Five-years basically just pulled a complete reversal. They were 3 bps wider on the day, but now they're 1 bps tighter."

Callables remained robust.

"Callables continue to do well as bullet spreads tighten up and volatility is at historically high levels," the trader added.

Fannie Mae prices at 43.5 bps

Fannie Mae priced $3 billion of new five-year Benchmark Notes at a spread of 43.5 bps over Treasuries on Thursday, according to a press release by the agency.

Price talk was at a spread of 41 bps, which Wall Street Access, in a market commentary, called "a little on the tight side."

A syndicate source said the offering was "received pretty well."

"We had quite a number of accounts that were interested," the syndicate source said.

Fund managers were the biggest buyers of the deal, taking 62% of the notes, according to data from Fannie Mae. Central banks were the next biggest investors with 13.2% of the notes, followed by state and local governments with 13%. Commercial banks bought just 2.6%, behind insurance companies.

U.S. investors bought 82.7% of the offering, while investors in Asia bought 10.6% and 2.6% went to European investors.

The new notes ended the day bid at 41 bps, the agency trader said. The deal was probably cheapened because the five-year sector was initially wider.

"They whole sector just cheapened by 2.5 bps this morning, and the agency five-year sector especially has been under pressure this week," the trader said.

Fed targets five-years

The Federal Reserve Bank of New York said Thursday that it will target agency paper due 2013 to 2016 in its Friday open-market purchase operations.

The announcement helped to offset the new supply from Fannie Mae and was a bit of an unexpected move, the agency trader said.

"I think the Fed buyback in the five-year sector was a bit of a surprise to us," the trader said.

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