Five-year agency spreads widen on surprise Fannie Mae offering; new deal talk at 33 to 35 bps

By Kenneth Lim

Boston, Oct. 22 - Five-year agency spreads expanded on Thursday with Fannie Mae's surprise announcement of a benchmark-sized deal in the sector, while the rest of the curve stayed mostly unchanged.

Agency spreads ended the day flat, an agency trader said.

"The market really in terms of outright yields didn't do a lot today," the trader said. "Not a huge amount of spreads trading. It's really just the new issue stuff pushing spreads around."

Callables were more lively, with issuance continuing at a brisk pace. In a recurring theme, step-up structures are most in demand, although floating-rate products also saw good interest, the trader said.

"Federal Farm Credit [Banks] and Federal Home Loan [Banks] will bring one- to three-month Libor floaters, and those have been quite popular," the trader said. "Those are the kinds of things that have been moving."

Thin volumes

Secondary market volumes have been weak the entire week, the trader said.

"Today was a little quiet...volumes have been very, very light this week," the trader said. "The central banks that were more active in the recent past have been more quiet this week. Pension funds and mutual funds that have been more active at the long end have been quiet also."

Part of the hesitation may stem from a sense that the agency market is kind of hovering in the middle of a range at the moment.

"We're kind of in the middle of the range now, and clients are kind of unwilling to make a move," the trader said.

Investors could return if yields look more attractive.

"If 10-years break through 3.5%...if we get higher yields, clients will be willing to put more money to work," the trader said.

Fannie Mae surprises market

Fannie Mae announced that it will price new five-year Benchmark bullet notes on Friday.

Barclays Capital Inc., Deutsche Bank Securities Inc. and J.P. Morgan & Co. are the lead managers.

Price talk, which is at a spread of 33 to 35 basis points over Treasuries, is about 2 bps cheaper than the curve, the trader said. The size of the deal will be at least $3 billion.

"The concessions have come down a lot recently," the trader said. "Anywhere from 1.5 to 2.5 bps is the norm now."

The decision to issue new notes in the five-year space came as a surprise to the market, which was expecting something closer to the front end, and pushed five-year spreads slightly wider.

"Most of the Street was expecting three-years, so the five-years are wider by about 2 bps," the trader said.

But the market was not entirely thrown off-guard.

"Let's say about 75% of the people expected three-years, about 25% expected five-years," the trader said. "It was a surprise, and the five-years moved out 2 bps, but the three-years didn't move at all. It was not that big of a surprise."

Although recent deals, such as Freddie Mac's $3.5 billion of new 1.125% Reference Notes due 2011 earlier in the week, have managed to sell above the $3 billion minimum for a benchmark-sized deal, Friday's Fannie Mae offering may not sell as much, the trader reckoned.

"They've had kind of weird sizes recently," the trader said. "Like the Freddie Mac $3.5 billion two-years recently. I would expect them to grow it to $4 billion or keep it at $3 billion. But the five-year will be a harder sale. I would expect a $3 billion size."

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