Agencies tighten slightly on quieter Friday; Fed buys $2.793 billion, within expectations

By Kenneth Lim

Boston, Sept. 11 - Agency spreads continued to tighten for the third day in a row on Friday, while the Federal Reserve Bank of New York's weekly buying program came within Street expectations.

Agency spreads ended about 0.5 basis points tighter despite a strong morning, an agency trader said.

Federal Home Loan Banks' new 1.625% Global notes due 2012, which priced Thursday, were flat at a spread against Treasuries of 29.5 bps bid, 29 bps offered.

"Spreads were initially tighter today about 1 to 2 bps across the curve based on the fact that swap spreads came in," the trader said. "Since then we have had absolute rates sellers come in, but agencies are still maybe about 0.5 bps tighter on the day. It's been fairly quiet."

Callables remained active, with step-ups the structure of the moment, as institutional and retail clients saw the instruments as good defense and yield-enhancement structures, the trader said.

"There's still demand for callables, all kinds of structures, but we have seen a lot of buying in step-ups, it's kind of a defense kind of play," the trader said.

Fed buys four- to six-years

The Fed on Friday bought $2.793 billion of four- to six-year agency securities through its weekly open-market operations.

The paper that was targeted mature in 2013, 2014, 2015 and 2016. A total of $6.209 billion of notes were offered, representing an acceptance rate of about 45%.

"They took 45%, and that's been roughly what they've been taking," the trader said. "I don't think that was hugely out of the realm of what they've been buying."

The Fed's $200 billion agency securities buying program could be extended from its current expiry at the end of 2009, wrote Barclays Capital agency analysts Rajiv Setia and James Ma in a research note.

"Thus far, the Fed has $78 billion in capacity remaining in its agency purchase program," the analysts wrote.

"At the current $3 billion weekly run rate of purchases, this would put the program sunset into March 2010. However, we expect the debate on the GSEs' future to only be in its infancy at that time, given the current Congressional focus on healthcare. In our view, to mitigate cliff effects, the Fed will likely slow its pace of purchases in Q4 and extend the sunset of the program well into 2010."

Watching levels

Absolute yields will be a key factor in the week ahead, the trader said.

"It's going to depend on the level of the market," the trader said. "If yields continue to come down, spreads will probably widen as more people are taking profit at those levels. On the flip side, if we were to go higher on yields, we will see guys buying."

The agency market is likely to bounce within a range, the trader added.

"People are really just buying the range right now," the trader said.

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